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Newcastle
Investment
Corp.
Annual Report 2009
Fellow Shareholders:
When we wrote to you last year, the real estate debt and equity markets were effectively closed. In
2009, we experienced continued stress and volatility. In the beginning of the year, asset prices
declined sharply, bottoming out around June. Due to insufficient liquidity, a number of real estate
finance companies were taken over by lenders and others were completely shut down. Credit mar-
kets began to show signs of recovery in the second half of the year, and spreads tightened and bond
prices increased as the markets became more rational in the pricing of risk. For Newcastle, 2009
was all about strengthening our balance sheet and liquidity, maximizing cash flows from our
portfolio and managing credit risk.
Strengthening our balance sheet and liquidity:
• In the beginning of 2009, we restructured $154 million of
non-agency recourse debt, eliminating all mark-to-market
provisions and debt covenants. For the year, our goal was
to substantially eliminate this debt. As a result of these
efforts, we reduced these borrowings by $112 million to
$42 million at year-end. By the end of the third quarter of
2010, all of this recourse debt is scheduled to be paid off.
• At the same time we were paying off debt, we increased
the unrestricted cash on our balance sheet by $18 million
from $50 million to $68 million at year-end.
• Our efforts to increase cash and reduce recourse debt
resulted in an overall liquidity improvement of $130 mil-
lion during the year and allowed us to end 2009 with
more unrestricted cash than short-term non-agency
recourse debt.
• In 2009, we also looked for ways to reduce the cost of our
borrowings. For example, we restructured our $100 million
of junior subordinated notes, reducing the interest rate
from 7.57% to 1% for up to six quarters. This resulted in a
total cost savings in 2009 of $5 million. We have since
retired $52 million of this debt at a substantial discount.
• In the first quarter of 2010, we tendered for $91 million of our
outstanding preferred stock at a price significantly below
par. This transaction and the junior subordinated note
repurchase were highly accretive to our common stock,
and we eliminated $12 million in annual interest and divi-
dend expense.
Maximizing cash flows:
• As you may know, a majority of our operating cash flow
comes from our CDOs. In 2009, our CDOs generated $73
million of cash to Newcastle. We are highly focused on
continuing to maximize this cash flow in three of our
CDOs. We will seek to achieve this by investing in assets
with low risk and high returns, particularly those we can
acquire at a steep discount to par, and by repurchasing
CDO liabilities at accretive levels.
Managing credit risk:
• Aggressive portfolio management is key in these times.
We are focused on reducing credit risk and, at the same
time, improving returns and our credit profile. In 2009, we
sold $497 million of assets with an average credit rating of
“BB-” and an average yield of 11%. We purchased $463
million of assets with an average rating of “AA-” and an
average yield of 15%. In 2010, we will continue to seek
ways to opportunistically improve our portfolio.
We enter 2010 with a stronger balance sheet and liquidity
for investment. Our focus for the year will be to rebuild
shareholder value. In the first quarter we made good prog-
ress towards that goal. We will continue to look for oppor-
tunities to buy back our debt at discounted prices and to
invest or deleverage in ways that are accretive to sharehold-
ers. Even though the credit markets have improved, there is
still a long way to go, and that presents great investment
opportunities. Today, investment capital is limited and
companies with cash to invest can dictate the best terms
and structure the most attractive investments.
On behalf of everyone at Newcastle, we thank you for your
continued support as we remain committed to our business
and its future.
Kenneth M. Riis
Chief Executive Officer and President
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
Commission File Number: 001-31458
(Exact name of registrant as specified in its charter)
Newcastle Investment Corp.___________________________
Maryland
(State or other jurisdiction of incorporation
or organization)
81-0559116
(I.R.S. Employer Identification No.)
1345 Avenue of the Americas, New York, NY
(Address of principal executive offices)
10105
(Zip Code)
Registrant’s telephone number, including area code: (212) 798-6100
Securities registered pursuant to Section 12 (b) of the Act:
Title of each class:
Common Stock, $0.01 par value per share
9.75% Series B Cumulative Redeemable Preferred
Stock, $0.01 par value per share
8.05% Series C Cumulative Redeemable Preferred
Stock, $0.01 par value per share
8.375% Series D Cumulative Redeemable Preferred
Stock, $0.01 par value per share
Name of exchange on which registered:
New York Stock Exchange (NYSE)
New York Stock Exchange (NYSE)
New York Stock Exchange (NYSE)
New York Stock Exchange (NYSE)
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes X No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes X No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
X Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).
Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-K or any amendment to this form 10-K ____
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or
smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act. (Check One):
Large Accelerated Filer Accelerated Filer Non-accelerated Filer X Smaller Reporting Company ___
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). (Check
One):
Yes X No
The aggregate market value of the voting common stock held by non-affiliates as of June 30, 2009 (computed based on the
closing price on such date as reported on the NYSE) was: $31 million.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.
Common stock, $0.01 par value per share: 52,912,513 outstanding as of February 17, 2010.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant’s definitive proxy statement for the Registrant’s 2010 annual meeting, to be filed within
120 days after the close of the Registrant’s fiscal year, are incorporated by reference into Part III of this Annual
Report on Form 10-K.
CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform
Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments,
the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of
forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,”
“anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other
similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations,
describe future plans and strategies, contain projections of results of operations or of financial condition or state other
forward-looking information. Our ability to predict results or the actual outcome of future plans or strategies is inherently
uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable
assumptions, our actual results and performance could differ materially from those set forth in the forward-looking
statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual
results in future periods to differ materially from forecasted results. Factors which could have a material adverse effect on
our operations and future prospects include, but are not limited to:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
reductions in cash flows received from our investments, particularly our CDOs;
our ability to take advantage of opportunities in additional asset classes at attractive risk-adjusted prices;
our ability to deploy capital accretively;
the risks that default and recovery rates on our loan portfolios exceed our underwriting estimates;
the relationship between yields on assets which are paid off and yields on assets in which such monies can be
reinvested;
the relative spreads between the yield on the assets we invest in and the cost of financing;
changes in economic conditions generally and the real estate and bond markets specifically;
adverse changes in the financing markets we access affecting our ability to finance our investments, or in a manner
that maintains our historic net spreads;
changing risk assessments by lenders that potentially lead to increased margin calls, not extending our repurchase
agreements or other financings in accordance with their current terms or entering into new financings with us;
changes in interest rates and/or credit spreads, as well as the success of any hedging strategy we may undertake in
relation to such changes;
the quality and size of the investment pipeline and the rate at which we can invest our cash, including cash inside
our CDOs;
impairments in the value of the collateral underlying our investments and the relation of any such impairments to
our judgments as to whether changes in the market value of our securities, loans or real estate are temporary or not
and whether circumstances bearing on the value of such assets warrant changes in carrying values;
legislative/regulatory changes, including but not limited to, any modification of the terms of loans;
completion of pending investments;
the availability and cost of capital for future investments;
competition within the finance and real estate industries; and
other risks detailed from time to time below, particularly under the heading “Risk Factors,” and in our other SEC
reports.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. The factors noted above could cause our actual results to
differ significantly from those contained in any forward-looking statement.
Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our
management’s views only as of the date of this report. We are under no duty to update any of the forward-looking
statements after the date of this report to conform these statements to actual results.
SPECIAL NOTE REGARDING EXHIBITS
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K, please remember they are included
to provide you with information regarding their terms and are not intended to provide any other factual or disclosure
information about the Company or the other parties to the agreements. The agreements contain representations and
warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely
for the benefit of the other parties to the applicable agreement and:
•
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk
tone of the parties if those statements provide to be inaccurate;
have been qualified by disclosures that were made to the other party in connection with the negotiation of the
applicable agreement, which disclosures are not necessarily reflected in the agreement;
• may apply standards of materiality in a way that is different from what may be viewed as material to you or other
investors; and
• were made only as of the date of the applicable agreement or such other date or dates as may be specified in the
agreement and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made
or at any other time. Additional information about the Company may be found elsewhere in this Annual Report on
Form 10-K and the Company’s other public filings, which are available without charge through the SEC’s website at
http://www.sec.gov. See “Where Readers Can Find Additional Information.”
NEWCASTLE INVESTMENT CORP.
FORM 10-K
INDEX
PART I
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Properties
Legal Proceedings
Item 4.
Submission of Matters to a Vote of Security Holders
PART II
Item 5.
Item 6.
Item 7.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and
Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Report on Internal Control over Financial Reporting of Independent Registered
Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2009 and December 31, 2008
Consolidated Statements of Operations for the years ended December 31, 2009, 2008
and 2007
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended
December 31, 2009, 2008 and 2007
Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008
and 2007
Notes to Consolidated Financial Statements
Page
1
11
28
28
28
28
28
30
32
51
54
55
56
57
58
59
61
63
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 98
Item 9A.
Controls and Procedures
Management’s Report on Internal Control over Financial Reporting
Item 9B.
Other Information
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Directors, Executive Officers and Corporate Governance
Executive Compensation
PART III
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
Item 15.
Exhibits; Financial Statement Schedules
Signatures
PART IV
2
98
98
99
99
99
99
99
99
100
101
Item 1. Business.
Overview
PART I
Newcastle Investment Corp. (“Newcastle”) is a real estate related investment and finance company. Newcastle invests in,
and actively manages a portfolio of, real estate securities, loans and other real estate related assets. Our objective is to
maximize the difference between the yield on our investments and the cost of financing these investments while hedging
our interest rate risk. We emphasize portfolio management, asset quality, liquidity, diversification, match funded financing
and credit risk management.
We conduct our business through four primary segments: (i) investments financed with non-recourse collateralized debt
obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt,
including FNMA / FHLMC securities, and (iv) unlevered investments. Further details regarding the revenues, net income
(loss) and total assets of each of our segments for each of the last three fiscal years are presented in Note 3 to Part II, Item
8, “Financial Statements and Supplementary Data.”
The following table summarizes our segments at December 31, 2009:
GAAP
Investments (C) (E)
Cash and restricted cash
Other assets
Total assets
Debt
CDOs (A)
Non-Recourse (A) (B)
Recourse
Unlevered
Unallocated
Total
Other
$ 2,389,325
$ 732,658
$ 72,808
$ 6,678
$ -
$ 3,201,469
202,461
-
3,056
461
67,700
273,678
36,643
2,628,429
-
732,658
605
76,469
4
7,143
2,229
69,929
39,481
3,514,628
(4,058,928) (706,703) (71,309) -
(103,264) (4,940,204)
Derivative liabilities
(181,913) (22,689) (2,552) -
-
(207,154)
Other liabilities
Total liabilites
Preferred stock
(2,197) (795) (520) (165) (4,245) (7,922)
(5,155,280)
(4,243,038)
(165) (107,509)
(730,187)
(74,381)
-
-
-
-
(152,500) (152,500)
GAAP book value (D)
$ (1,614,609) $ 2,471
$ 2,088
$ 6,978
$ (190,080) $ (1,793,152)
(A) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the
extent we receive net cash flow distributions from such structures. Furthermore, our economic losses from such structures cannot exceed our
invested equity in them. Therefore, economically, their book value cannot be less than zero, except for the amount described in note (B)
below.
Includes all of the manufactured housing loan financing, of which $10.1 million (carrying value) was recourse as of December 31, 2009.
Investments in the unlevered segment include $2.3 million of real estate securities, $4.2 million of real estate related loans and $0.2 million
of interests in a joint venture at December 31, 2009. A real estate related loan of $4.1 million was pledged as collateral for the junior
subordinated notes and will be released at the end of the interest rate modification period.
(B)
(C)
(D) Newcastle cannot economically lose more than its investment amount in any given non-recourse financing structure. Therefore, impairment
recorded in excess of such investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot
economically be incurred and will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or
termination of such non-recourse financing structure. For non-recourse financing structures with negative GAAP book value, except as
noted in (B) above, the aggregate negative GAAP book value which will eventually be recorded as income is $1.0 billion as of December
31, 2009.
Included in the other non-recourse segment was $403.0 million of Investments and Debt at December 31, 2009, representing the loans
subject to call option of the two subprime securitizations and the corresponding financing.
(E)
Our investments cover four distinct categories:
1) Real Estate Securities:
We underwrite, acquire and manage a diversified portfolio of credit sensitive
real estate securities, including commercial mortgage backed securities
(CMBS), senior unsecured REIT debt issued by REITs, real estate related
securities, and
asset backed
FNMA/FHLMC securities. As of December 31, 2009, our real estate securities
represented 52.1% of our assets.
including
securities
subprime
(ABS),
2) Real Estate Related Loans:
3) Residential Mortgage Loans:
We acquire and originate loans to real estate owners, including B-notes,
mezzanine loans, corporate bank loans, and whole loans. As of December 31,
2009, our real estate related loans represented 16.3% of our assets.
We acquire residential mortgage loans, including manufactured housing loans
and subprime mortgage loans. As of December 31, 2009, our residential
mortgage loans represented 10.9% of our assets.
1
4) Operating Real Estate:
We acquire and manage direct and indirect interests in operating real estate.
As of December 31, 2009, our operating real estate represented 0.3% of our
assets.
In addition, Newcastle had restricted and unrestricted cash and other miscellaneous net assets, which represented 8.9% of
our assets at December 31, 2009.
Newcastle generally seeks to use a match fund strategy in financing our investments, when appropriate and available, in
order to reduce refinancing and interest rate risks. This means that we seek both to match the maturities of our debt
obligations with the maturities of our investments, in order to reduce the risk that we have to refinance our liabilities prior
to the maturities of our assets, and to match the interest rates on our investments with like-kind debt (i.e., floating or fixed),
in order to reduce the impact of changing interest rates on our earnings.
Newcastle’s stock is traded on the New York Stock Exchange under the symbol “NCT.” Newcastle is a real estate
investment trust for federal income tax purposes and is externally managed and advised by an affiliate of Fortress
Investment Group LLC, or Fortress. For its services, our manager is entitled to a management fee and incentive
compensation pursuant to a management agreement. Our manager, through its affiliates, and principals of Fortress
collectively owned 3.8 million shares of our common stock and our manager, through its affiliates, had options to purchase
an additional 1.7 million shares of our common stock, which were issued in connection with our equity offerings,
representing approximately 10.0% of our common stock on a fully diluted basis, as of December 31, 2009.
As a result of the continued challenging credit and liquidity conditions, Newcastle faces a number of challenges, as further
described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations –
Market Considerations.”
2
Our Investment Strategy
Newcastle’s investment strategy focuses predominantly on debt investments secured by real estate. We do not have
specific policies as to the allocation among type of real estate related assets or investment categories since our investment
decisions depend on changing market conditions. Instead, we focus on relative value and in-depth risk/reward analysis.
Our focus on relative value means that assets which may be unattractive under particular market conditions may, if priced
appropriately to compensate for risks such as projected defaults and prepayments, become attractive relative to other
available investments. We generally utilize a match funded financing strategy, when appropriate and available, and active
management as part of our investment strategy. As discussed in Part II, Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations – Market Conditions,” the continued challenging credit and liquidity
conditions in the markets have reduced the current values of substantially all of our investments from historical levels, and
has resulted in impairments in certain investments.
The following summarizes our investment portfolio at December 31, 2009 (dollars in millions):
Investment (5)
Commercial
CMBS
Mezzanine Loans
B-Notes
Whole Loans
Total Commercial Assets
Residential
Manufactured Housing and Residential Mortgage Loans
Subprime Securities
Real Estate ABS
Subprime Retained Securities and Residuals
FNMA/FHLMC securities
Total Residential Assets
Corporate
REIT Debt
Corporate Bank Loans
Total Corporate Assets
TOTAL / WA
Reconciliation to GAAP total assets:
Net unrealized loss recorded in accumulated
other comprehensive income
Other assets
Subprime mortgage loans subject to call option (4)
Real estate held for sale
Cash and restricted cash
Other
GAAP total assets
WA – Weighted average, in all tables.
Outstanding Face
Amount
Amortized Cost
Basis (1)
Percentage of
Amortized Cost
Basis
Number of
Investments
Credit (2)
Weighted
Average Life
(years) (3)
$
2,458
718
308
93
3,577
$
1,467
240
80
55
1,842
484
463
86
62
1,095
46
1,141
518
314
832
375
187
66
2
630
46
676
513
199
712
45.4%
7.4%
2.5%
1.7%
57.0%
11.6%
5.8%
2.0%
0.1%
19.5%
1.4%
20.9%
15.9%
6.2%
22.1%
294
21
11
4
12,613
104
26
7
BB
69%
76%
36%
699
B
BB+
C
3
AAA
59
10
BB+
CCC-
$
5,550
$
3,230
100.0%
3.1
1.9
1.9
1.6
2.7
6.5
4.6
4.4
1.8
5.3
3.8
5.2
4.2
3.4
3.9
3.4
(454)
403
10
273
53
3,515
$
(1) Net of impairments.
(2) Credit represents weighted average of minimum rating for rated assets, LTV (based on the appraised value at the time
of purchase) for non-rated commercial assets, FICO score for non-rated residential assets and an implied AAA rating
for FNMA/FHLMC securities. Ratings provided above were determined by third party rating agencies as of a
particular date, may not be current and are subject to change (including the assignment of a “negative watch”) at any
time.
(3) Weighted average life represents the timing of expected principal reduction on the asset.
(4) Our subprime mortgage loans subject to call option are excluded from the statistics because they result from an option,
not an obligation, to repurchase such loans, are noneconomic until such option is exercised, and are offset by an equal
liability on the consolidated balance sheet.
(5) The following tables summarize certain supplemental data relating to our investments (dollars in tables in thousands):
3
CMBS
Deal Vintage
(A)
Pre 2004
2004
2005
2006
2007
2009
Total / WA
BBB+
BB+
BB-
BB+
B
BBB-
BB
Average
Minimum
Rating (B) Number
Percentage of
Amortized Cost
Basis
Delinquency
60+/FC/REO (C)
Principal
Subordination (D)
Weighted
Average Life
(years)
Outstanding
Face Amount
Amortized Cost
Basis
$
434,496
$
417,820
434,515
600,343
527,422
450,375
11,000
305,844
200,292
361,051
171,818
10,060
84
61
53
55
40
1
28.5%
20.8%
13.7%
24.6%
11.7%
0.7%
294
$
2,458,151
$
1,466,885
100.0%
5.0%
3.8%
3.0%
2.0%
4.8%
0.0%
3.6%
12.4%
5.7%
5.9%
10.9%
10.9%
0.0%
9.0%
3.1
3.5
3.0
3.1
2.4
9.9
3.1
(A) The year in which the securities were issued.
(B) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change
(including the assignment of a “negative watch”) at any time. We had approximately $850.9 million of CMBS assets that are on negative watch
for possible downgrade by at least one rating agency as of December 31, 2009.
(C) The percentage of underlying loans that are 60+ days delinquent, or in foreclosure or considered real estate owned (REO).
(D) The percentage of the outstanding face amount of securities that is subordinate to our investments.
Mezzanine Loans, B-Notes and Whole Loans
Outstanding Face Amount
Amortized Cost Basis
Number
Weighted Average First $ Loan to Value (A)
Weighted Average Last $ Loan to Value (A)
Delinquency (B)
Mezzanine Loans
B-Notes
Whole Loans
Total / WA
$
718,298
$
308,082
$
93,305
$
1,119,685
$
240,185
$
79,427
$
55,408
$
375,020
21
55.6%
69.3%
6.9%
11
61.9%
75.9%
42.7%
4
0.0%
36.1%
0.0%
36
52.7%
68.4%
16.2%
(A) Loan to value is based on the appraised value at the time of purchase.
(B) The percentage of underlying loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned.
Manufactured Housing and Residential Loans
Deal
Outstanding
Face Amount
Amortized
Cost Basis
Percentage of
Amortized
Cost Basis
Average
Loan Age
(months)
Original
Balance
Delinquency
90+/FC/REO
(A)
Cumulative
Loss to Date
Manufactured Housing Loans Portfolio I
$
170,452
$
119,482
Manufactured Housing Loans Portfolio II
243,781
202,025
Residential Loans Portfolio I
66,136
50,320
Residential Loans Portfolio II
Total / WA
3,794
484,163
$
3,516
375,343
$
31.8%
53.8%
13.4%
1.0%
100.0%
99
$
327,855
129
91
64
113
434,743
646,357
83,950
1,492,905
$
1.7%
1.3%
9.1%
0.0%
2.5%
5.5%
3.6%
0.2%
0.0%
3.8%
(A) The percentage of loans that are 90+ days delinquent, or in foreclosure or considered real estate owned.
Subprime Securities (A)
Average
Minimum
Rating (C)
BB-
B-
B
CCC
BB
Number of
Securities
15
31
38
12
8
Outstanding
Face Amount
$
22,147
96,253
162,249
102,604
79,250
Vintage (B)
2003
2004
2005
2006
2007
Security Characteristics
Amortized Cost
Basis
Percentage of
Amortized Cost
Basis
$
13,593
35,218
43,224
43,042
52,122
7.3%
18.8%
23.1%
23.0%
27.8%
Total / WA
B
104
$
462,503
$
187,199
100.0%
Principal
Subordination (D)
Excess
Spread (E)
21.3%
12.9%
24.2%
18.5%
29.5%
21.3%
4.4%
4.2%
5.1%
4.9%
4.7%
4.7%
Average
Loan Age
(months)
Collateral
Factor (F)
82
68
55
41
39
53
0.11
0.15
0.24
0.56
0.65
0.35
Collateral Characteristics
3 month
CPR (G)
8.9%
9.1%
13.4%
14.1%
20.6%
Delinquency (H)
17.4%
20.8%
35.8%
42.1%
34.1%
13.7%
32.9%
Vintage (B)
2003
2004
2005
2006
2007
Total / WA
Cumulative Losses
to Date
2.7%
2.7%
7.7%
10.5%
10.7%
7.5%
4
Real Estate ABS
Asset Type
Manufactured Housing
Small Business Loans
Total / WA
Asset Type
Average
Minimum
Rating (C)
BBB+
B
BB+
Average
Loan Age
(months)
Security Characteristics
Number
Face
Amount
Basis
Amount
Percentage of
Basis
Principal
Subordination (D)
Excess
Spread (E)
9
17
26
$
$
51,276
34,730
86,006
$
$
49,795
15,799
65,594
75.9%
24.1%
100.0%
36.8%
17.7%
29.1%
2.3%
3.4%
2.8%
Collateral Characteristics
Collateral
Factor (F)
3 Month
CPR (G)
Delinquency (H)
Cumulative
Loss to Date
Manufactured Housing
Small Business Loans
Total / WA
110
65
92
0.37
0.58
0.46
7.9%
4.7%
6.6%
4.5%
14.5%
8.5%
9.9%
4.3%
7.6%
(A) Excludes subprime retained securities and residual interests.
(B) The year in which the securities were issued.
(C) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change
(including the assignment of a “negative watch”) at any time. We had approximately $21.1 million of ABS securities that are on negative watch
for possible downgrade by at least one rating agency as of December 31, 2009.
(D) The percentage of the outstanding face amount of securities and residual interests that is subordinate to our investments.
(E) The annualized amount of interest received on the underlying loans in excess of the interest paid on the securities, as a percentage of the
outstanding collateral balance.
(F) The ratio of original unpaid principal balance of loans still outstanding.
(G) Three month average constant prepayment rate.
(H) The percentage of underlying loans that are 90+ days delinquent, in foreclosure, or considered real estate owned.
Subprime Retained Securities and Residual Interests
Represents $2.0 million and $0.02 million of amortized cost basis of retained bonds and residual interests, respectively,
in the securitizations of Subprime Portfolios I and II. For further information on these securitizations, see Note 5 to
Part II, Item 7, “Financial Statements and Supplementary Data.”
REIT Debt
Industry
Retail
Diversified
Office
Multifamily
Hotel
Healthcare
Storage
Industrial
Total / WA
Average
Minimum
Rating (A) Number
Outstanding
Face
Amount
Amortized
Cost Basis
Percentage of
Amortized
Cost Basis
BBB-
CCC+
BBB
BBB
BBB
BBB-
A-
BB-
BB+
17
12
12
4
4
6
1
3
59
$
$
142,460
123,836
125,469
18,765
30,220
51,600
5,000
20,865
518,215
134,512
124,344
127,532
17,537
30,771
51,379
5,073
21,372
512,520
$
$
26.2%
24.3%
24.9%
3.4%
6.0%
10.0%
1.0%
4.2%
100.0%
Corporate Bank Loans
Average
Minimum
Rating (A) Number
Outstanding
Face
Amount
Amortized
Cost Basis
Percentage of
Amortized
Cost Basis
D
CC
BB-
B
NR
B+
CCC-
3
2
1
2
1
1
10
$
$
82,828
112,000
71,449
19,400
27,000
1,457
314,134
48,943
42,956
64,363
16,065
25,110
1,391
198,828
$
$
24.6%
21.6%
32.4%
8.1%
12.6%
0.7%
100.0%
Industry
Real Estate
Media
Resorts
Restaurant
Transportation
Theatres
Total / WA
(A) Ratings provided above were determined by third party rating agencies as of a particular date, may not be current and are subject to change
(including the assignment of a “negative watch”) at any time. We did not have any REIT assets or bank loans that are on negative watch for
possible downgrade by any rating agency as of December 31, 2009.
5
Credit Risk Management
Credit risk refers to the ability of each individual borrower under our loans and securities to make required interest and
principal payments on the scheduled due dates. We strive to reduce credit risk by actively monitoring our asset portfolio
and the underlying credit quality of our holdings and, where appropriate, repositioning our investments to upgrade their
credit quality and yield. A significant portion of our investments are financed with collateralized debt obligations, known
as CDOs. Our CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and,
subject to certain limitations, to optimize returns.
Further, while the expected yield on our real estate securities, which comprise a meaningful portion of our assets, is
sensitive to the performance of the underlying loans, the first risk of default and loss - referred to as a “first loss” position-
is borne by the more subordinated securities or other features of the securitization transaction, in the case of commercial
mortgage and asset backed securities, and the issuer’s underlying equity and subordinated debt, in the case of senior
unsecured REIT debt securities. As a result of the continued challenging credit and liquidity conditions in the markets, the
value of the subordinated securities has generally been reduced or, in some cases, eliminated, which could leave our
securities economically in a first loss position. We also invest in loans and securities which represent “first loss” positions;
in other words, they do not benefit from credit support although we believe at acquisition they predominantly benefit from
underlying collateral value in excess of their carrying amounts.
Our Financing and Hedging Activities
We employ leverage as part of our investment strategy We do not have a predetermined target debt to equity ratio as we
believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As a
result of our negative GAAP equity, our GAAP debt to equity ratio is not a meaningful measure as of December 31, 2009.
Our general investment guidelines adopted by our board of directors limit total leverage (as defined under the governing
documents) to a maximum 9.0 to 1 debt to equity ratio. As of December 31, 2009, our debt to equity ratio as computed
under this methodology was approximately 4.2 to 1. We utilize leverage for the sole purpose of financing our portfolio and
not for the purpose of speculating on changes in interest rates.
We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential
fluctuations in the availability of capital. We utilize multiple forms of financing, including collateralized debt obligations
(CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans
and repurchase agreements. Further details regarding the forms of financing that we are currently able to utilize are
presented in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
under “– Market Considerations” and “– Liquidity and Capital Resources.” As discussed therein, the continued challenging
credit and liquidity conditions have limited the amount of capital resources available to us and made the terms of capital
resources we are able to obtain generally less favorable to us relative to the terms we were able to obtain prior to the onset
of challenging conditions. For example, we are currently contractually restricted from entering into new debt financings
subject to margin calls other than to finance up to a specified amount of FNMA/FHLMC securities.
Our manager may elect for us to bear a level of refinancing risk on a short term or longer term basis, such as is the case
with investments financed with repurchase agreements, when, based on all of the relevant factors, the manager determines
that bearing such risk is advisable or unavoidable.
We attempt to reduce refinancing and interest rate risks through the use of match funded financing structures, when
appropriate and available, whereby we seek (i) to match the maturities of our debt obligations with the maturities of our
assets and (ii) to match the interest rates on our investments with like-kind debt (i.e., floating rate assets are financed with
floating rate debt and fixed rate assets are financed with fixed rate debt), directly or through the use of interest rate swaps,
caps or other financial instruments, or through a combination of these strategies. We believe this allows us to reduce the
risk that we have to refinance our liabilities prior to the maturities of our assets and to reduce the impact of changing
interest rates on our earnings.
We enter into hedging transactions to protect our positions from interest rate fluctuations and other changes in market
conditions. These transactions predominantly include interest rate swaps, and may include the purchase or sale of interest
rate collars, caps or floors, options, mortgage derivatives and other hedging instruments, and may be subject to margin
calls. These instruments may be used to hedge as much of the interest rate risk as our manager determines is in the best
interest of our stockholders, given the cost of such hedges and the need to maintain our status as a REIT. Our manager
elects to have us bear a level of interest rate risk that could otherwise be hedged when our manager believes, based on its
analysis, that bearing such risks is advisable or unavoidable. We engage in hedging for the purpose of protecting against
interest rate risk and not for the purpose of speculating on changes in interest rates.
Further details regarding our hedging activities are presented in Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk-Fair Value.”
6
Debt Obligations
The following table presents certain summary information regarding our debt obligations and related hedges as of December 31, 2009 (unaudited) (dollars in thousands):
Outstanding
Face Amount Carrying Value
Weighted
Average
Funding
Cost (1)
Weighted
Average
Maturity
(Years)
Face Amount
of Floating
Rate Debt
Outstanding
Face Amount
(2)
Amortized Cost
Basis (2)
Carrying Value (2)
Weighted
Average
Maturity
(Years)
Floating Rate
Face Amount
(2)
Aggregate
Notional Amount
of Current
Hedges
Collateral
$
4,067,296
304,400
$
4,058,928
303,697
3.20%
6.03%
31,672
39,637
31,672
39,637
102,500
103,264
2.36%
5.01%
7.28%
3.49%
4.3
0.9
0.4
0.1
$
4,009,504
304,400
$
4,932,923
414,233
$
3,053,765
329,652
$
2,598,524
329,652
31,672
39,637
176,648
40,082
28,741
41,880
28,741
44,045
3.3
6.6
0.5
3.8
$
2,169,811
44,229
164,616
-
26.1
-
-
-
-
-
-
$
2,062,720
-
-
36,715
-
4.5
$
4,385,213
$
5,563,886
$
3,454,038
$
3,000,962
3.4
$
2,378,656
$
2,099,435
Debt Obligation
CDO Bonds Payable
Other Bonds Payable
Repurchase Agreements
Non-FNMA/FHLMC
FNMA/FHLMC
Junior Subordinated
Notes Payable
Subtotal debt obligations
4,545,505
4,537,198
Financing on Subprime
Mortgage Loans Subject
to Call Option
406,217
403,006
Total debt obligations
$
4,951,722
$
4,940,204
(1) Including the effect of applicable hedges.
(2)
Including restricted cash held for reinvestment in CDOs. The face amount and carrying value of Newcastle’s unlevered investments (real estate loans and securities) were $190.3 million and $6.7 million, respectively, as of
December 31, 2009.
Further details regarding our debt obligations are presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital
Resources,” as well as Note 8 to Part II, Item 8, “Financial Statements and Supplementary Data.”
7
Formation
We were formed in June 2002 as a subsidiary of Newcastle Investment Holdings Corp. Prior to our initial public offering,
Newcastle Investment Holdings contributed to us certain assets and related liabilities in exchange for approximately 16.5
million shares of our common stock. Our operations commenced in July 2002. In May 2003, Newcastle Investment
Holdings distributed to its stockholders all of the shares of our common stock that it owned, and it no longer owns any of
our equity.
The following table presents information on shares of our common stock issued since our formation:
Year
Shares Issued
Range of Issue
Prices (1)
Net Proceeds
(millions)
Formation - 2004
2005
2006
2007
2008
2009
December 31, 2009
39,859,481
4,053,928
1,800,408
7,065,362
9,871
123,463
52,912,513
$29.60
$29.42
$27.75-$31.30
N/A
N/A
$108.2
$51.2
$201.3
$0.1
$0.1
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors.
Investment Guidelines
Our general investment guidelines, adopted by our board of directors, include:
•
•
•
•
no investment is to be made which would cause us to fail to qualify as a REIT;
no investment is to be made which would cause us to be regulated as an investment company;
no more than 20% of our total equity, determined as of the date of such investment, is to be invested in any single
asset;
our leverage (as defined in our governing documents) is not to exceed 90% of the sum of our total debt and our
total equity; and
• we are not to co-invest with the manager or any of its affiliates unless (i) our co-investment is otherwise in
accordance with these guidelines and (ii) the terms of such co-investment are at least as favorable to us as to the
manager or such affiliate (as applicable) making such co-investment.
In addition, our manager is required to seek the approval of the independent members of our board of directors before we
engage in a material transaction with another entity managed by our manager or any of its affiliates. These investment
guidelines may be changed by our board of directors without the approval of our stockholders.
The Management Agreement
We are party to a management agreement with FIG LLC, an affiliate of Fortress Investment Group LLC, dated June 23,
2003, pursuant to which FIG LLC, our manager, provides for the day-to-day management of our operations.
The management agreement requires our manager to manage our business affairs in conformity with the policies and the
investment guidelines that are approved and monitored by our board of directors. Our manager manages our operations
under the direction of our board of directors. The manager is responsible for, among other things, (i) the purchase and sale
of real estate securities and loans and other real estate related assets, (ii) the financing of our real estate securities and loans
and other real estate related assets, (iii) management of our real estate, including arranging for purchases, sales, leases,
maintenance and insurance, (iv) the purchase, sale and servicing of loans for us, and (v) investment advisory services. Our
manager is responsible for our day-to-day operations and performs (or causes to be performed) such services and activities
relating to our assets and operations as may be appropriate.
We pay our manager an annual management fee equal to 1.5% of our gross equity, as defined in the management
agreement. The management agreement provides that we will reimburse our manager for various expenses incurred by our
manager or its officers, employees and agents on our behalf, including costs of legal, accounting, tax, auditing,
administrative and other similar services rendered for us by providers retained by our manager or, if provided by our
manager’s employees, in amounts which are no greater than those which would be payable to outside professionals or
consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis.
To provide an incentive for our manager to enhance the value of our common stock, our manager is entitled to receive an
incentive return (the “Incentive Compensation”) on a cumulative, but not compounding, basis in an amount equal to the
product of (A) 25% of the dollar amount by which (1) (a) our funds from operations, as defined in the management
8
agreement (before the Incentive Compensation), per share of common stock (based on the weighted average number of
shares of common stock outstanding) plus (b) gains (or losses) from debt restructuring and from sales of property and other
assets per share of common stock (based on the weighted average number of shares of common stock outstanding), exceed
(2) an amount equal to (a) the weighted average of the price per share of common stock in our initial public offering and the
value attributed to the net assets transferred to us by Newcastle Investment Holdings, and in any of our subsequent
offerings (adjusted for prior capital dividends or capital distributions) multiplied by (b) a simple interest rate of 10% per
annum (divided by four to adjust for quarterly calculations) multiplied by (B) the weighted average number of shares of
common stock outstanding. Our manager earned no incentive compensation during 2009, 2008 or the second half of 2007.
We expect that there will be no incentive compensation payable to our manager for an indeterminate period of time.
The management agreement provides for automatic one year extensions. Our independent directors review our manager’s
performance annually and the management agreement may be terminated annually upon the affirmative vote of at least two-
thirds of our independent directors, or by a vote of the holders of a majority of the outstanding shares of our common stock,
based upon unsatisfactory performance that is materially detrimental to us or a determination by our independent directors
that the management fee earned by our manager is not fair, subject to our manager’s right to prevent such a management
fee compensation termination by accepting a mutually acceptable reduction of fees. Our manager must be provided with
60 days’ prior notice of any such termination and would be paid a termination fee equal to the amount of the management
fee earned by our manager during the twelve month period preceding such termination, which may make it difficult and
costly for us to terminate the management agreement. Following any termination of the management agreement, we shall
be entitled to purchase our manager’s right to receive the Incentive Compensation at a price determined as if our assets
were sold for cash at their then current fair market value (as determined by an appraisal, taking into account, among other
things, the expected future value of the underlying investments) or otherwise we may continue to pay the Incentive
Compensation to our manager. In addition, if we do not purchase our manager’s Incentive Compensation, our manager
may require us to purchase the same at the price discussed above. In addition, the management agreement may be
terminated by us at any time for cause.
Policies With Respect to Certain Other Activities
Subject to the approval of our board of directors, we have the authority to offer our common stock or other equity or debt
securities in exchange for property and to repurchase or otherwise reacquire our shares or any other securities and may
engage in such activities in the future.
We also may make loans to, or provide guarantees of certain obligations of, our subsidiaries.
Subject to the percentage ownership and gross income and asset tests necessary for REIT qualification, we may invest in
securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the
purpose of exercising control over such entities.
We may engage in the purchase and sale of investments.
Our officers and directors may change any of these policies and our investment guidelines without a vote of our
stockholders.
In the event that we determine to raise additional equity capital, our board of directors has the authority, without
stockholder approval (subject to certain NYSE requirements), to issue additional common stock or preferred stock in any
manner and on such terms and for such consideration it deems appropriate, including in exchange for property.
Decisions regarding the form and other characteristics of the financing for our investments are made by our manager
subject to the general investment guidelines adopted by our board of directors.
Competition
We are subject to significant competition in seeking investments. We compete with several other companies for
investments, including other REITs, insurance companies and other investors. Some of our competitors have greater
resources than we possess, or have greater access to capital or various types of financing than are available to us, and we
may not be able to compete successfully for investments.
Compliance with Applicable Environmental Laws
Properties we own (directly or indirectly) or may acquire are or would be subject to various foreign, federal, state and local
environmental laws, ordinances and regulations. Under these laws, ordinances and regulations, a current or previous owner
of real estate (including, in certain circumstances, a secured lender that succeeds to ownership or control of a property) may
become liable for the costs of removal or remediation of certain hazardous or toxic substances or petroleum product
releases at, on, under or in its property. These laws typically impose cleanup responsibility and liability without regard to
whether the owner or control party knew of or was responsible for the release or presence of the hazardous or toxic
substances. The costs of investigation, remediation or removal of these substances may be substantial and could exceed the
9
value of the property. An owner or control party of a site may be subject to common law claims by third parties based on
damages and costs resulting from environmental contamination emanating from a site. Certain environmental laws also
impose liability in connection with the handling of or exposure to asbestos-containing materials, pursuant to which third
parties may seek recovery from owners of real properties for personal injuries associated with asbestos-containing
materials. Our operating costs and values of these assets may be adversely affected by the obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations, as well as the cost of complying with future
legislation, and our income and ability to make distributions to our stockholders could be affected adversely by the
existence of an environmental liability with respect to our properties. We endeavor to ensure that properties we own or
acquire will be in compliance in all material respects with all foreign, federal, state and local laws, ordinances and
regulations regarding hazardous or toxic substances or petroleum products.
Employees
As described above under “The Management Agreement,” we are managed by FIG LLC, an affiliate of Fortress Investment
Group LLC. As a result, we have no employees. From time to time, certain of our officers may enter into written
agreements with us that memorialize the provision of certain services; these agreements do not provide for the payment of
any cash compensation to such officers from us. The employees of FIG LLC are not a party to any collective bargaining
agreement.
Corporate Governance and Internet Address; Where Readers Can Find Additional Information
We emphasize the importance of professional business conduct and ethics through our corporate governance initiatives.
Our board of directors consists of a majority of independent directors; the Audit, Nominating and Corporate Governance,
and Compensation committees of our board of directors are composed exclusively of independent directors. We have
adopted corporate governance guidelines, and our manager has adopted a code of business conduct and ethics, which
delineate our standards for our officers and directors, and employees of our manager.
Newcastle files annual, quarterly and current reports, proxy statements and other information required by the Securities
Exchange Act of 1934, as amended (the ‘‘Exchange Act’’), with the Securities and Exchange Commission (“SEC”).
Readers may read and copy any document that Newcastle files at the SEC’s Public Reference Room located at 100 F Street,
N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further information on the Public
Reference Room. Our SEC filings are also available to the public from the SEC’s internet site at http://www.sec.gov.
Copies of these reports, proxy statements and other information can also be inspected at the offices of the New York Stock
Exchange, Inc., 20 Broad Street, New York, New York 10005, U.S.A.
Our internet site is http://www.newcastleinv.com. We make available free of charge through our internet site our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and Forms 3, 4 and
5 filed on behalf of directors and executive officers and any amendments to those reports filed or furnished pursuant to the
Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Also posted on our website in the ‘‘Investor Relations—Corporate Governance” section are charters for the company’s
Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee as well as our
Corporate Governance Guidelines and our Code of Business Conduct and Ethics governing our directors, officers and
employees. Information on, or accessible through, our website is not a part of, and is not incorporated into, this report.
10
Item 1A. Risk Factors
Risks relating to our management, business and company include, specifically:
Risks Related to the Financial Markets
We do not know what impact the U.S. government’s programs to attempt to stabilize the economy and the financial
markets will have on our business. The government’s current efforts to modify terms of outstanding loans
negatively affects our business, financial condition and results of operations.
Over the past two years, the U.S. government has taken a number of steps to attempt to stabilize the global financial
markets and U.S. economy, including direct government investments in, and guarantees of, troubled financial institutions as
well as government-sponsored programs such as the Term Asset-Backed Securities Loan Facility program (TALF) and the
Public Private Investment Partnership Program (PPIP). Members of Congress are also currently evaluating an array of
other measures and programs that purport to help improve U.S. financial and market conditions. While conditions appear
to have improved relative to the depths of the global financial crisis, it is not clear whether this improvement is real or will
last for a significant period of time. Moreover, it is not clear what impact the government’s future plans to improve the
global economy and financial markets will have on our business. To date, we have not benefited in a direct, material way
from any government programs, and we may not derive any meaningful benefit from these programs in the future.
Moreover, if any of our competitors are able to benefit from one or more of these initiatives, they may gain a significant
competitive advantage over us.
In addition, the U.S. government has enacted legislation that enables government agencies to modify the terms of a
significant number of residential and other loans to provide relief to borrowers without the applicable investor’s consent.
These modifications allow for outstanding principal to be deferred, interest rates to be reduced, the length of the loan to be
extended or other terms to be changed in ways that can permanently eliminate the cash flow (principal and interest)
associated with a portion of the loan. These modifications are currently reducing, or in the future may reduce, the value of
a number of our mortgage-backed securities and other investments. As a result, such loan modifications are negatively
affecting our business, results of operations and financial condition. In addition, certain market participants propose
reducing the amount of paperwork required by a borrower to modify their loan, which could increase the likelihood of
fraudulent modifications and materially harm the U.S. mortgage market and investors that have exposure to this market.
Risks Relating to Our Management
We are dependent on our manager and may not find a suitable replacement if our manager terminates the
management agreement.
We have no employees. Our officers and other individuals who perform services for us are employees of our manager. We
are completely reliant on our manager, which has significant discretion as to the implementation of our operating policies
and strategies, to conduct our business. We are subject to the risk that our manager will terminate the management
agreement and that we will not be able to find a suitable replacement for our manager in a timely manner, at a reasonable
cost or at all. Furthermore, we are dependent on the services of certain key employees of our manager whose compensation
is partially or entirely dependent upon the amount of incentive or management compensation earned by our manager and
whose continued service is not guaranteed and the loss of such services could adversely affect our operations.
There are conflicts of interest in our relationship with our manager.
Our chairman serves as an officer of our manager. Our management agreement with our manager was not negotiated at
arm's-length and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an
unaffiliated third party.
There are conflicts of interest inherent in our relationship with our manager insofar as our manager and its affiliates —
including investment funds, private investment funds, or businesses managed by our manager — invest in real estate
securities, real estate related loans and operating real estate and whose investment objectives overlap with our investment
objectives. Certain investments appropriate for Newcastle may also be appropriate for one or more of these other
investment vehicles. Members of our board of directors and employees of our manager who are our officers may serve as
officers and/or directors of these other entities. In addition, our manager or its affiliates may have investments in and/or
earn fees from such other investment vehicles which are larger than their economic interests in Newcastle and which may
therefore create an incentive to allocate investments to such other investment vehicles. Our manager or its affiliates may
determine, in their discretion, to make a particular investment through another investment vehicle rather than through
Newcastle and have no obligation to offer to Newcastle the opportunity to participate in any particular investment
opportunity. Accordingly, it is possible that we may not be given the opportunity to participate at all in certain investments
made by our affiliates that meet our investment objectives.
Our management agreement with our manager generally does not limit or restrict our manager or its affiliates from
engaging in any business or managing other pooled investment vehicles that invest in investments that meet our investment
objectives, except that under our management agreement neither our manager nor any entity controlled by or under
common control with our manager is permitted to raise or sponsor any new pooled investment vehicle whose investment
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policies, guidelines or plan targets as its primary investment category investment in United States dollar-denominated credit
sensitive real estate related securities reflecting primarily United States loans or assets. Our manager intends to engage in
additional real estate related management and investment opportunities in the future which may compete with us for
investments.
The ability of our manager and its officers and employees to engage in other business activities, subject to the terms of our
management agreement with our manager, may reduce the time our manager, its officers or other employees spend
managing Newcastle. In addition, we may engage in material transactions with our manager or another entity managed by
our manager or one of its affiliates, including certain financing arrangements and co-investments which present an actual,
potential or perceived conflict of interest, subject to our investment guidelines. It is possible that actual, potential or
perceived conflicts could give rise to investor dissatisfaction, litigation or regulatory enforcement actions. Appropriately
dealing with conflicts of interest is complex and difficult, and our reputation could be damaged if we fail, or appear to fail,
to deal appropriately with one or more potential, actual or perceived conflicts of interest. Regulatory scrutiny of, or
litigation in connection with, conflicts of interest could have a material adverse effect on our reputation which could
materially adversely affect our business in a number of ways, including causing an inability to raise additional funds, a
reluctance of counterparties to do business with us, a decrease in the prices of our common and preferred securities and a
resulting increased risk of litigation and regulatory enforcement actions.
The management compensation structure that we have agreed to with our manager may incentivize our manager to invest in
high risk investments. In addition to its management fee, our manager is entitled to receive incentive compensation based in
part upon our achievement of targeted levels of funds from operations. In evaluating investments and other management
strategies, the opportunity to earn incentive compensation based on funds from operations may lead our manager to place
undue emphasis on the maximization of funds from operations at the expense of other criteria, such as preservation of
capital, in order to achieve higher incentive compensation, particularly in light of the fact that our manager has not received
any incentive compensation and likely will not receive any incentive compensation in the future unless it meaningfully
increases Newcastle’s investment returns. Investments with higher yield potential are generally riskier or more speculative
than lower-yielding investments. Moreover, because our manager receives compensation in the form of options in
connection with the completion of our common equity offerings, our manager may be incentivized to cause us to issue
additional common stock, which could be dilutive to existing shareholders.
It would be difficult and costly to terminate our management agreement with our manager.
Termination of the management agreement with our manager would be difficult and costly. The management agreement
may only be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by a vote
of the holders of a majority of the outstanding shares of our common stock, based upon (1) unsatisfactory performance by
our manager that is materially detrimental to us or (2) a determination that the management fee payable to our manager is
not fair, subject to our manager's right to prevent such a compensation termination by accepting a mutually acceptable
reduction of fees. Our manager will be provided 60 days' prior notice of any termination and will be paid a termination fee
equal to the amount of the management fee earned by the manager during the twelve-month period preceding such
termination. In addition, following any termination of the management agreement, the manager may require us to purchase
its right to receive incentive compensation at a price determined as if our assets were sold for their fair market value (as
determined by an appraisal, taking into account, among other things, the expected future value of the underlying
investments) or otherwise we may continue to pay the incentive compensation to our manager. These provisions may
increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to
terminate our manager without cause.
Our directors have approved very broad investment guidelines for our manager and do not approve each
investment decision made by our manager.
Our manager is authorized to follow very broad investment guidelines. Consequently, our manager has great latitude in
determining the types of assets it may decide are proper investments for us. Our directors periodically review our
investment guidelines and our investment portfolio. However, our board does not review or pre-approve each proposed
investment or our related financing arrangements. In addition, in conducting periodic reviews, the directors rely primarily
on information provided to them by our manager. Furthermore, transactions entered into by our manager may be difficult or
impossible to unwind by the time they are reviewed by the directors even if the transactions contravene the terms of the
management agreement.
We may change our investment strategy without stockholder consent, which may result in our making investments
that entail more risk than our current investments.
Our investment strategy may evolve, in light of existing market conditions and investment opportunities, and this evolution
may involve additional risks depending upon the nature of such assets and our ability to finance such assets on a short or
long term basis. Investment opportunities that present unattractive risk-return profiles relative to other available investment
opportunities under particular market conditions may become relatively attractive under changed market conditions and
changes in market conditions may therefore result in changes in the investments we target. Decisions to make investments
in new asset categories present risks that may be difficult for us to adequately assess and could therefore reduce the stability
of our dividends or have adverse effects on our financial condition. A change in our investment strategy may also increase
our exposure to interest rate, foreign currency, real estate market or credit market fluctuations. Our failure to accurately
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assess the risks inherent in new asset categories or the financing risks associated with such assets could adversely affect our
results of operations and our financial condition.
Risks Relating to Our Business
Challenging market conditions will likely continue to negatively impact our business, results of operations and
financial condition.
The market in which we operate is affected by a number of factors that are largely beyond our control but can nonetheless
have a potentially significant, negative impact on us. These factors include, among other things:
•
Interest rates and credit spreads;
• The availability of credit, including the price, terms and conditions under which it can be obtained;
• The quality, pricing and availability of suitable investments and credit losses with respect to our investments;
• The ability to obtain accurate market-based valuations;
• Loan values relative to the value of the underlying real estate assets;
• Default rates on both commercial and residential mortgages and the amount of the related losses;
• The actual and perceived state of the real estate markets, market for dividend-paying stocks and public capital
markets generally;
• Unemployment rates; and
• The attractiveness of other types of investments relative to investments in real estate or REITs generally.
Changes in these factors are difficult to predict, and a change in one factor can affect other factors. For example, during
2007, increased default rates in the subprime mortgage market played a role in causing credit spreads to widen, reducing
availability of credit on favorable terms, reducing liquidity and price transparency of real estate related assets, resulting in
difficulty in obtaining accurate mark-to-market valuations, and causing a negative perception of the state of the real estate
markets and of REITs generally. These conditions worsened during 2008, and intensified meaningfully during the fourth
quarter of 2008, as a result of the global credit and liquidity crisis, resulting in extraordinarily challenging market
conditions. Despite signs of moderate improvement, market conditions during 2009 and early 2010 remain significantly
challenging. We do not currently know the full extent to which this market disruption will affect us or the markets in which
we operate, and we are unable to predict its length or ultimate severity. If the challenging conditions continue, we may
experience additional impairment charges as well as additional challenges in raising capital and obtaining investment or
other financing on attractive terms.
A prolonged economic slowdown, a lengthy or severe recession, or declining real estate values could harm our
operations.
We believe the risks associated with our business are more severe during periods similar to those we are currently
experiencing in which an economic slowdown or recession is accompanied by declining real estate values. Declining real
estate values generally reduce the level of new mortgage loan originations, since borrowers often use increases in the value
of their existing properties to support the purchase of, or investment in, additional properties. Borrowers may also be less
able to pay principal and interest on our loans, and the loans underlying our securities, if the real estate economy weakens.
Further, declining real estate values significantly increase the likelihood that we will incur losses on our loans and securities
in the event of default because the value of our collateral may be insufficient to cover our basis. Any sustained period of
increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans and
securities in our portfolio as well as our ability to originate, sell and securitize loans, which would significantly harm our
revenues, results of operations, financial condition, liquidity, business prospects and our ability to make distributions to our
shareholders. For more information on the impact of the continued challenging credit and liquidity conditions on our
business and results of operations see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations – Market Considerations.”
We have limited liquidity. We are party to agreements that require cash payments at periodic intervals, including
during the next nine months. Failure to make such required payments have a material adverse affect on our
business, financial condition and results of operations.
We are currently party to non-FNMA/FHLMC recourse financing agreements that require us to make cash payments at
periodic intervals. During the period from January 1, 2010 through September 30, 2010, we are required to make principal
payments under these financing agreements of approximately $41.9 million, which represents all amounts outstanding
under such recourse financing agreements. Events could occur or circumstances could arise, which we may not be able to
foresee, that may cause us to be unable to make these cash payments when they become due. Failure to make the payments
required under our financing documents would give the lenders the right to require us to repay all amounts owed to them
under the applicable financing immediately.
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The use of CDO financings with coverage tests may have a negative impact on our operating results and cash flows.
We have retained, and may in the future retain, subordinate classes of bonds issued by certain of our subsidiaries in our
CDO financings. Each of our CDO financings contains tests that measure the amount of over collateralization and excess
interest in the transaction. Failure to satisfy these tests would result in principal and/or interest cash flow that would
otherwise be distributed to more junior classes of securities (including those held by Newcastle) to be redirected to pay
down the most senior class of securities outstanding until the tests are satisfied. As a result, failure to satisfy the coverage
tests could adversely affect our operating results and cash flows by temporarily or permanently directing funds that would
otherwise come to us to holders of the senior classes of bonds. In addition, the redirected funds would be used to pay down
financing which currently bears an attractive rate, thereby reducing our future earnings from the affected CDO. The ratings
assigned to the assets in each CDO affect the results of the tests governing whether a CDO can distribute cash to the various
classes of securities in the CDO. As a result, ratings downgrades of the assets in a CDO can result in a CDO failing its tests
and thereby cause us not to receive cash flows from the affected CDO. We note that we have approximately $1.1 billion of
assets in our CDOs as of January 31, 2010 that are under negative watch for possible downgrade by at least one of the
rating agencies. One or more of the rating agencies could downgrade some or all of these assets at any time, and any such
downgrade could affect – and possibly materially affect – our future cash flows. As of February 17, 2010, CDOs IV, V, VI
and VII were not in compliance with their applicable over collateralization tests and, consequently, we are not receiving
cash flows from these CDOs (other than senior management fees). Based upon our current calculations, we expect these to
remain out of compliance for the foreseeable future. Moreover, given current market conditions, it is possible that all of our
CDOs could be out of compliance with their over collateralization tests as of one or more measurement dates within the
next twelve months.
Our ability to rebalance will depend upon the availability of suitable securities, market prices, whether the reinvestment
period of the applicable CDO has ended, and other factors that are beyond our control. For example, in prior periods, we
were able to repurchase notes issued by the CDOs and subsequently cancel those notes in accordance with the terms of the
relevant governing documentation. These cancellations assisted the applicable CDO in satisfying its overcollateralization
test as of the next testing date and thereby enabled the cash flow from that CDO to be distributed to the junior classes of
securities (including those held by Newcastle). The trustee of all of our CDOs recently informed us that, if we wish to
cancel CDO debt in the future, they will require us to obtain the approval of the noteholders of the applicable CDO. If we
are unable to obtain the requisite noteholder consent, we will be unable to use CDO debt cancellations as a tool to help
CDOs satisfy their overcollateralization tests and thereby maintain the flow of cash from that CDO to Newcastle. As a
result, holders of our common shares and preferred shares should not expect that we will be able to cancel any of our CDO
obligations in the future. While there are other permissible methods to rebalance or otherwise correct CDO test failures,
such methods may be extremely difficult to employ given current market conditions, and we cannot assure you that we will
be successful in our rebalancing efforts. If the liabilities of our CDOs are downgraded by Moody’s to certain predetermined
levels, our discretion to rebalance the applicable CDO portfolios may be negatively impacted. Moreover, if we bring these
coverage tests into compliance, we cannot assure you that they will not fall out of compliance in the future or that we will
be able to correct any noncompliance.
Failure of the over collateralization tests can also cause a “phantom income” issue if cash that constitutes income is diverted
to pay down debt instead of distributed to us. For more information regarding noncompliance with the terms of certain of
our CDO financings in the near future, please see Part I, Item 2, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations–Liquidity and Capital Resources” and “–Debt Obligations.”
We may experience an event of default or the removal of us as collateral manager under one or more of our CDOs,
which would negatively affect us in a number of ways.
The documentation governing our CDOs specify certain events of default, which, if they occur, would negatively affect us.
Events of default include, among other things, failure to pay interest on senior classes of securities within the CDO,
breaches of covenants, representations or warranties, bankruptcy, and failure to satisfy specific over collateralization and
interest coverage tests. If an event of default occurs under any of our CDOs, it would negatively affect our cash flows,
business, results of operations and financial condition.
In addition, we can be removed as manager of a CDO if certain events occur, including the failure to satisfy specific over
collateralization and interest coverage tests, failure to satisfy certain “key man” requirements or an event of default
occurring for the failure to pay interest on the related senior classes of securities of the CDO. If we are removed as
collateral manager, we would no longer receive management fees from — and no longer be able to manage the assets of —
the applicable CDO, which would negatively affect our cash flows, business, results of operations and financial condition.
We note that since the filing of our Quarterly Report on Form 10-Q for the period ended September 30, 2009 on November
4, 2009, CDO VII failed additional over collateralization tests. The consequences of failing these tests are that an event of
default has occurred and we may be removed as the collateral manager under the documentation governing CDO VII. So
long as the event of default continues, we will not be permitted to purchase or sell any collateral in CDO VII. If we are
removed as the collateral manager of CDO VII, we would no longer receive the senior management fees from such CDO.
As of February 17, 2010, we have not been removed as collateral manager. Based upon our current calculations, we
estimate that if we are removed as the collateral manager of CDO VII, the loss of senior management fees would not have a
material negative impact on our cash flows, business, results of operations or financial condition. However, given current
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market conditions, it is possible that events of default may occur in other CDOs, and we could be removed as the collateral
manager of those CDOs if certain events of default occur. Moreover, our cash flows, business, results of operations and/or
financial condition could be materially and negatively impacted if certain events of default occur.
Our investments have previously been — and in the future may be — subject to significant impairment charges,
which adversely affect our results of operations.
We are required to periodically evaluate our investments for impairment indicators. The value of an investment is impaired
when our analysis indicates that, with respect to a loan, it is probable that we will not be able to collect the full amount we
intended to collect from the loan or, with respect to a security, it is probable that the value of security is other than
temporarily impaired. The judgment regarding the existence of impairment indicators is based on a variety of factors
depending upon the nature of the investment and the manner in which the income related to such investment calculated for
purposes of our financial statements. If we determine that an impairment has occurred, we are required to make an
adjustment to the net carrying value of the investment, which could adversely affect our results of operations and funds
from operations in the applicable period and thereby adversely affect our ability to pay dividends to our stockholders.
As has been widely publicized, the continued challenging credit and liquidity conditions have resulted in a number of
financial institutions recording an unprecedented amount of impairment charges, and we have also been affected by these
conditions. These challenging conditions have reduced the market trading activity for many real estate securities, resulting
in less liquid markets for those securities. These lower valuations have affected us by, among other things, decreasing our
net book value and contributing to our decision to record impairment charges.
The lenders under any repurchase agreements that we may enter into from time to time may elect not to extend
financing to us, which could quickly and seriously impair our liquidity.
We have historically financed a meaningful portion of our investments not held in CDOs with repurchase agreements,
which are short-term financing arrangements, and we may enter into additional repurchase agreements in the future. Under
the terms of these agreements, we sell a security to a counterparty for a specified price and concurrently agree to repurchase
the same security from our counterparty at a later date for a higher specified price. During the term of the repurchase
agreement – generally 30 days – the counterparty makes funds available to us and holds the security as collateral. Our
counterparties can also require us to post additional margin as collateral at any time during the term of the agreement.
When the term of a repurchase agreement ends, we are required to repurchase the security for the specified repurchase
price, with the difference between the sale and repurchase prices serving as the equivalent of paying interest to the
counterparty in return for extending financing to us. If we want to continue to finance the security with a repurchase
agreement, we ask the counterparty to extend – or “roll” – the repurchase agreement for another term.
Our counterparties are not required to roll our repurchase agreements upon the expiration of the stated terms, which
subjects us to a number of risks. As we have experienced recently and may experience in the future, counterparties electing
to roll our repurchase agreements may charge higher spread and impose more onerous terms upon us, including the
requirement that we post additional margin as collateral. More significantly, if a repurchase agreement counterparty elects
not to extend our financing, we would be required to pay the counterparty the full repurchase price on the maturity date and
find an alternate source of financing. Alternate sources of financing may be more expensive, contain more onerous terms or
simply may not be available. If we were unable to pay the repurchase price for any security financed with a repurchase
agreement, the counterparty has the right to sell the underlying security being held as collateral and require us to
compensate them for any shortfall between the value of our obligation to the counterparty and the amount for which the
collateral was sold (which may be sold at a significantly discounted price). As of December 31, 2009, we had $39.6
million in repurchase agreement obligations relating to FNMA/FHLMC securities. Moreover, all of our FNMA/FHLMC
securities are financed under a repurchase agreement with one counterparty. If this counterparty elected not to roll this
repurchase agreement, it is likely that we would not be able to find a replacement counterparty in a timely manner.
Our determination of how much leverage to apply to our investments may adversely affect our return on our
investments and may reduce cash available for distribution.
We leverage our portfolio through borrowings, generally through the use of credit facilities, warehouse facilities,
repurchase agreements, mortgage loans on real estate, securitizations, including the issuance of CDOs, private or public
offerings of debt by subsidiaries, loans to entities in which we hold, directly or indirectly, interests in pools of properties or
loans, and other borrowings. Our investment policies do not limit the amount of leverage we may incur with respect to any
specific asset or pool of assets, subject to an overall limit on our use of leverage to 90% (as defined in our governing
documents) of the value of our assets on an aggregate basis. As a result of the continued challenging credit and liquidity
conditions, the return we are able to earn on our investments and cash available for distribution to our stockholders has
been significantly reduced due to changes in market conditions causing the cost of our financing to increase relative to the
income that can be derived from our assets.
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We are subject to counterparty default and concentration risks.
In the ordinary course of our business, we enter into various types of financing arrangements with counterparties.
Currently, the majority of our financing arrangements take the form of repurchase agreements, securitization vehicles,
loans, hedge contracts, swaps and other derivative and non-derivative contracts. The terms of these contracts are often
customized and complex, and many of these arrangements occur in markets or relate to products that are not subject to
regulatory oversight.
We are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily,
on its performance under the contract. Any such default may occur rapidly and without notice to us. Moreover, if a
counterparty defaults, we may be unable to take action to cover our exposure, either because we lack the contractual ability
or because market conditions make it difficult to take effective action. This inability could occur in times of market stress
consistent with the conditions we are currently experiencing, which are precisely the times when defaults may be most
likely to occur.
In addition, our risk-management processes may not accurately anticipate the impact of market stress or counterparty
financial condition, and as a result, we may not take sufficient action to reduce our risks effectively. Although we monitor
our credit exposures, default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In
addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other
participants, which may in turn expose us to significant losses.
In the event of a counterparty default, particularly a default by a major investment bank, we could incur material losses
rapidly, and the resulting market impact of a major counterparty default could seriously harm our business, results of
operations and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our
ability to eventually recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of
the counterparty or the applicable legal regime governing the bankruptcy proceeding.
In addition, with respect to our CDOs, certain of our derivative counterparties are required to maintain certain ratings to
avoid having to post collateral or transfer the derivative to another counterparty. If the counterparty was downgraded below
these levels they may not be able to satisfy their obligations under the derivative, which could have a material negative
effect on the applicable CDO.
The counterparty risks that we face have increased in complexity and magnitude as a result of the deterioration of
conditions in the financial markets and weakening or insolvency of a number of major financial institutions (such as Bear
Stearns, Lehman Brothers, Merrill Lynch, Citigroup and AIG). For example, the consolidation and elimination of
counterparties has increased our concentration of counterparty risk and decreased the universe of potential counterparties.
We currently finance all of our FNMA/FHLMC securities under a repurchase agreement with one counterparty. If this
counterparty elected not to roll this repurchase agreement, it is likely that we would not be able to find a replacement
counterparty, which could negatively impact us in a number of ways, including forcing us to sell these securities at
distressed prices and use cash on hand to make up for any additional amounts needed to repay the counterparty. Moreover,
because we currently hold our FNMA/FHLMC securities mainly to maintain our exemption under the Investment Company
Act, the sale of these securities may, if we are unable to return to compliance, require us to register as an investment
company or cause us to lose our REIT status, either of which would negatively impact us in a number of ways described
below. In addition, counterparties have generally reacted to the ongoing market volatility by tightening their underwriting
standards and increasing their margin requirements for all categories of financing, which has negatively impacted us in
several ways, including, decreasing the number of counterparties willing to provide financing to us, decreasing the overall
amount of leverage available to us, and increasing the costs of borrowing. As a result, we currently finance all of our assets
not held in CDOs with a very concentrated number of counterparties. If one or more of these counterparties elected not to
continue to provide financing to us, we would likely not be able to find substitute financing in a timely manner or on
economical terms, which could, in turn, significantly harm our ability to conduct our business, our financial condition and
results of operations.
We are not restricted from dealing with any particular counterparty or from concentrating any or all of our transactions with
one counterparty. Any loss suffered by us as a result of a counterparty defaulting, refusing to conduct business with us or
imposing more onerous terms on us would also negatively affect our business, results of operations and financial condition.
Although we seek to match fund our investments to limit refinance risk and lock in net spreads, we do not currently
match fund our investments not held in our CDOs, which increases the risks related to refinancing these
investments.
A key to our investment strategy is to finance our investments using match funded financing structures, which match assets
and liabilities with respect to maturities and interest rates. This strategy limits our refinance risk, including the risk of being
able to refinance an investment on favorable terms or at all. We generally use match funded financing structures, such as
CDOs, to finance our investments in real estate securities and loans. However, our manager may elect for us to bear a level
of refinancing risk on a short term or longer term basis, such as is the case with investments financed with repurchase
agreements, when, based on its analysis, our manager determines that bearing such risk is deemed advisable or unavoidable
(this is generally the case with respect to the residential mortgage loans and FNMA/FHLMC in which we invest). In
addition, we may be unable, as a result of conditions in the credit markets, to match fund investments. For example,
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non-recourse term financing not subject to margin requirements was generally not available or economical for the past two
years and is currently still challenging to obtain, which impairs our ability to match fund our investments. The decision
not, or the inability, to match fund certain investments exposes us to additional refinancing risks that may not apply to our
other investments.
Furthermore, we anticipate that, in most cases, for any period during which our floating rate assets are not match funded
with respect to maturity, the income from such assets may respond more slowly to interest rate fluctuations than the cost of
our borrowings. Because of this dynamic, interest income from such investments may rise more slowly than the related
interest expense, with a consequent decrease in our net income. Interest rate fluctuations resulting in our interest expense
exceeding interest income would result in operating losses for us from these investments.
Accordingly, if we do not or are unable to match fund our investments with respect to maturities and interest rates, we will
be exposed to the risk that we may not be able to finance or refinance our investments on economically favorable terms or
may have to liquidate assets at a loss.
We may not be able to finance our investments on a long term basis on attractive terms, including by means of
securitization, which may require us to seek more costly financing for our investments or to liquidate assets.
When we acquire securities and loans that we finance on a short term basis with a view to securitization or other long term
financing, we bear the risk of being unable to securitize the assets or otherwise finance them on a long term basis at
attractive prices or in a timely matter, or at all. If it is not possible or economical for us to securitize or otherwise finance
such assets on a long term basis, we may be unable to pay down our short term credit facilities, or be required to liquidate
the assets at a loss in order to do so. For example, as a result of the continued deterioration in the credit markets beginning
in 2007, financing investments with securitizations or other long-term non-recourse financing not subject to margin
requirements was generally not available or economical for the past two years, and is currently still challenging to obtain.
These conditions make it highly likely that we will have to use less efficient forms of financing for any new investments,
which will likely require a larger portion of our cash flows to be put toward making the initial investment and thereby
reduce the amount of cash available for distribution to our stockholders and funds available for operations and investments,
and which will also likely require us to assume higher levels of risk when financing our investments.
The loans we invest in, and the loans underlying the securities and total rate of return swaps we invest in, are
subject to delinquency, foreclosure and loss, which could result in losses to us.
Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of delinquency and
foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by an income-producing property typically
is dependent primarily upon the successful operation of such property rather than upon the existence of independent income
or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may
be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix,
success of tenant businesses, property management decisions, property location and condition, competition from
comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any
need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property,
changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local
real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, changes in the
availability of credit on favorable terms, real estate tax rates and other operating expenses, changes in governmental rules,
regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil
disturbances.
Residential mortgage loans, manufactured housing loans and subprime mortgage loans are secured by single-family
residential property and are also subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower
to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of
factors may impair borrowers' abilities to repay their loans, including, among other things, changes in the borrower’s
employment status, changes in national, regional or local economic conditions, changes in interest rates or the availability
of credit on favorable terms, changes in regional or local real estate values, changes in regional or local rental rates and
changes in real estate taxes.
In the event of any default under a loan held directly by us, we will bear a risk of loss of principal to the extent of any
deficiency between the value of the collateral and the outstanding principal and accrued but unpaid interest of the loan,
which could adversely affect our cash flow from operations. Foreclosure of a loan, particularly a commercial loan, can be
an expensive and lengthy process, which would negatively affect our anticipated return on the foreclosed loan.
Mortgage and asset backed securities are bonds or notes backed by loans and/or other financial assets and include
commercial mortgage back securities (CMBS), FNMA/FHLMC securities, and real estate related asset backed securities
(ABS). The ability of a borrower to repay these loans or other financial assets is dependent upon the income or assets of
these borrowers. If a borrower has insufficient income or assets to repay these loans, it will default on its loan. While we
intend to focus on real estate related asset backed securities, there can be no assurance that we will not invest in other types
of asset backed securities.
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Our investments in mortgage and asset backed securities will be adversely affected by defaults under the loans underlying
such securities. To the extent losses are realized on the loans underlying the securities in which we invest, the Company
may not recover the amount invested in, or, in extreme cases, any of our investment in, such securities.
We have recently experienced increased default rates on our commercial and residential mortgage loans.
Our investments in debt securities are subject to specific risks relating to the particular issuer of the securities and
to the general risks of investing in subordinated real estate securities.
Our investments in debt securities involve special risks. REITs generally are required to invest substantially in real estate or
real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed in this
report. Our investments in debt are subject to the risks described above with respect to mortgage loans and MBS and
similar risks, including:
•
•
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risks of delinquency and foreclosure, and risks of loss in the event thereof;
the dependence upon the successful operation of and net income from real property;
risks generally incident to interests in real property; and
risks that may be presented by the type and use of a particular property.
Debt securities may be unsecured and may also be subordinated to other obligations of the issuer. We may also invest in
debt securities that are rated below investment grade. As a result, investments in debt securities are also subject to risks of:
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limited liquidity in the secondary trading market;
substantial market price volatility resulting from changes in prevailing interest rates or credit spreads;
subordination to the prior claims of senior lenders to the issuer;
the possibility that earnings of the debt security issuer may be insufficient to meet its debt service; and
the declining creditworthiness and potential for insolvency of the issuer of such debt securities during periods of
rising interest rates and economic downturn.
These risks may adversely affect the value of outstanding debt securities and the ability of the issuers thereof to repay
principal and interest.
We are subject to significant competition and we may not compete successfully.
We are subject to significant competition in seeking investments. We compete with other companies, including other
REITs, insurance companies and other investors, including funds and companies affiliated with our manager. Some of our
competitors have greater resources than we possess or have greater access to capital or various types of financing structures
than are available to us, and we may not be able to compete successfully for investments or provide attractive investment
returns relative to our competitors. Furthermore, competition for investments of the type to be made by us may lead to the
returns available from such investments decreasing, which may further limit our ability to generate our desired returns. We
cannot assure you that other companies will not be formed that compete with us for investments or otherwise pursue
investment strategies similar to ours or that we will be able to complete successfully against any such companies.
Both during the ramp up phase of a potential CDO financing and following the closing of a CDO financing when we
have locked in the liability costs for a CDO during the reinvestment period, the rate at which we are able to acquire
eligible investments and changes in market conditions may adversely affect our anticipated returns.
We seek to acquire real estate securities and loans and finance them on a long term basis, typically through the issuance of
collateralized debt obligations. We use short term warehouse lines of credit or other arrangements to finance the acquisition
of real estate securities and loans until a sufficient quantity of assets are accumulated, at which time we may refinance these
lines through a securitization, such as a CDO financing, or other long term financing. As a result, we are subject to the risk
that we will not be able to acquire, during the period that any warehouse facility or short-term financing is available, a
sufficient amount of eligible assets to maximize the efficiency of a collateralized debt obligation financing. In addition,
conditions in the capital markets may make the issuance of a collateralized debt obligation impossible or economically
unattractive to us when we do have a sufficient pool of collateral. If we are unable to issue a collateralized debt obligation
to finance these assets, we may be required to seek other forms of less attractive financing or otherwise to liquidate the
assets.
In addition, following each CDO financing we must invest both the net cash raised in the financing as well as cash proceeds
of any prepayment or assets which we determine to sell. Until we are able to acquire sufficient assets, our returns will
reflect income earned on uninvested cash and, having locked in the cost of liabilities for the particular CDO, the particular
CDO’s returns will be at risk of declining to the extent that yields on the assets to be acquired decline.
In general, our ability to acquire appropriate investments depends upon the supply in the market of investments we deem
suitable, and changes in various economic factors may affect our determination of what constitutes a suitable investment.
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Our returns will be adversely affected when investments held in CDOs are prepaid or sold subsequent to the
reinvestment period.
Real estate securities and loans are subject to prepayment risk. In addition, we may sell, and realize gains (or losses) on,
investments. To the extent such assets were held in CDOs subsequent to the end of the reinvestment period, the proceeds
are fully utilized to pay down the related CDOs debt. This causes the leverage on the CDO to decrease, thereby lowering
our returns on equity.
Our investments in senior unsecured REIT securities are subject to specific risks relating to the particular REIT
issuer and to the general risks of investing in subordinated real estate securities, which may result in losses to us.
Our investments in REIT securities involve special risks relating to the particular REIT issuer of the securities, including
the financial condition and business outlook of the issuer. REITs generally are required to substantially invest in operating
real estate or real estate related assets and are subject to the inherent risks associated with real estate related investments
discussed in this report.
Our investments in REIT securities are also subject to the risks described above with respect to mortgage loans and
mortgage backed securities and similar risks, including (i) risks of delinquency and foreclosure, and risks of loss in the
event thereof, (ii) the dependence upon the successful operation of and net income from real property, (iii) risks generally
incident to interests in real property, and (iv) risks that may be presented by the type and use of a particular commercial
property.
REIT securities are generally unsecured and may also be subordinated to other obligations of the issuer. We may also invest
in REIT securities that are rated below investment grade. As a result, investments in REIT securities are also subject to
risks of: (i) limited liquidity in the secondary trading market, (ii) substantial market price volatility resulting from changes
in prevailing interest rates, (iii) subordination to the prior claims of banks and other senior lenders to the issuer, (iv) the
operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could
cause the issuer to reinvest premature redemption proceeds in lower yielding assets, (v) the possibility that earnings of the
REIT issuer may be insufficient to meet its debt service and dividend obligations and (vi) the declining creditworthiness
and potential for insolvency of the issuer of such REIT securities during periods of rising interest rates and economic
downturn. These risks may adversely affect the value of outstanding REIT securities and the ability of the issuers thereof to
repay principal and interest or make dividend payments.
The real estate related loans and other direct and indirect interests in pools of real estate properties or other loans
that we invest in may be subject to additional risks relating to the structure and terms of these transactions, which
may result in losses to us.
We invest in real estate related loans and other direct and indirect interests in pools of real estate properties or loans such as
mezzanine loans and “B Note” mortgage loans. We invest in mezzanine loans that take the form of subordinated loans
secured by second mortgages on the underlying real property or other business assets or revenue streams or loans secured
by a pledge of the ownership interests of the entity owning real property or other business assets or revenue streams (or the
ownership interest of the parent of such entity). These types of investments involve a higher degree of risk than long term
senior lending secured by business assets or income producing real property because the investment may become unsecured
as a result of foreclosure by a senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership
interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be
sufficient to repay our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the
event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is repaid in full. As a result,
we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan to value ratios than
conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.
We also invest in mortgage loans (“B Notes”) that while secured by a first mortgage on a single large commercial property
or group of related properties are subordinated to an “A Note” secured by the same first mortgage on the same collateral.
As a result, if an issuer defaults, there may not be sufficient funds remaining for B Note holders. B Notes reflect similar
credit risks to comparably rated commercial mortgage backed securities. In addition, we invest, directly or indirectly, in
pools of real estate properties or loans. However, since each transaction is privately negotiated, these investments can vary
in their structural characteristics and risks. For example, the rights of holders of B Notes to control the process following a
borrower default may vary from transaction to transaction, while investments in pools of real estate properties or loans may
be subject to varying contractual arrangements with third party co-investors in such pools. Further, B Notes typically are
secured by a single property, and so reflect the risks associated with significant concentration. These investments also are
less liquid than commercial mortgage backed securities.
We may not be able to extend any total return swaps that we enter into in the event that the maturity of the
underlying asset is extended, which could adversely impact our leveraging strategy.
Subject to maintaining our qualification as a REIT, from time to time we leverage certain of our investments through the
use of total return swaps. While we are not currently party to any total return swaps, we may enter into one or more total
return swaps in the future. We may wish to renew many of such swaps, which are for specified terms, as they mature,
particularly in the event that the maturity of the underlying asset is extended. However, there is a limited number of
providers of such swaps, and there is no assurance the initial swap providers will choose to renew the swaps, and — if they
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do not renew — that we would be able to obtain suitable replacement providers. Providers may choose not to renew our
total return swaps for a number of reasons, including:
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increases in the provider’s cost of funding;
insufficient volume of business with a particular provider;
a desire by our company to invest in a type of swap that the provider does not view as economically attractive due
to changes in interest rates or other market factors; or
the inability of our company and a provider to agree on terms.
Furthermore, our ability to invest in total return swaps, other than through a taxable REIT subsidiary, or TRS, may be
severely limited by the REIT qualification requirements because total return swaps are not qualifying assets and do not
produce qualifying income for purposes of the REIT asset and income tests.
Investment in non-investment grade loans may involve increased risk of loss.
We acquire and may continue to acquire in the future certain loans that do not conform to conventional loan criteria applied
by traditional lenders and are not rated or are rated as non-investment grade (for example, for investments rated by
Moody’s Investors Service, ratings lower than Baa3, and for Standard & Poor’s, BBB- or below). The non-investment
grade ratings for these loans typically result from the overall leverage of the loans, the lack of a strong operating history for
the properties underlying the loans, the borrowers’ credit history, the properties’ underlying cash flow or other factors. As a
result, these loans have a higher risk of default and loss than conventional loans. Any loss we incur may reduce
distributions to our stockholders. There are no limits on the percentage of unrated or non-investment grade assets we may
hold in our portfolio.
Insurance on real estate in which we have interests (including the real estate serving as collateral for our real estate
securities and loans) may not cover all losses.
There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or
acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances,
environmental considerations, and other factors, including terrorism or acts of war, also might make the insurance proceeds
insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds
received might not be adequate to restore our economic position with respect to the affected real property. As a result of the
events of September 11, 2001, insurance companies are limiting and/or excluding coverage for acts of terrorism in
insurance policies. As a result, we may suffer losses from acts of terrorism that are not covered by insurance.
In addition, the mortgage loans that are secured by certain of the properties in which we have interests contain customary
covenants, including covenants that require property insurance to be maintained in an amount equal to the replacement cost
of the properties. There can be no assurance that the lenders under these mortgage loans will not take the position that
exclusions from coverage for losses due to terrorist acts is a breach of a covenant which, if uncured, could allow the lenders
to declare an event of default and accelerate repayment of the mortgage loans.
Many of our investments are illiquid, and this lack of liquidity could significantly impede our ability to vary our
portfolio in response to changes in economic and other conditions or to realize the value at which such investments
are carried if we are required to dispose of them.
The real estate properties that we own and operate and our other direct and indirect investments in real estate and real estate
related assets are generally illiquid. Our investments in unconsolidated subsidiaries are also illiquid. In addition, the real
estate securities that we purchase in connection with privately negotiated transactions are not registered under the relevant
securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that
is exempt from the registration requirements of, or is otherwise in accordance with, those laws. In addition, there are no
established trading markets for a majority of our investments. As a result, our ability to vary our portfolio in response to
changes in economic and other conditions may be limited.
Our securities have historically been valued based primarily on third party quotations, which are subject to significant
variability based on the liquidity and price transparency created by market trading activity. The ongoing dislocation in the
trading markets has continued to reduce the trading for many real estate securities, resulting in less transparent prices for
those securities. Consequently, it is currently more difficult for us to sell many of our assets now that it has been
historically because, if we were to sell such assets, we will likely not have access to readily ascertainable market prices
when establishing valuations of them. Moreover, currently there is a relatively low market demand for the vast majority of
the types of assets that we hold, which may make it extremely difficult to sell assets. If we are required to liquidate all or a
portion of our illiquid investments quickly, we may realize significantly less than the amount at which we have previously
valued these investments.
Interest rate fluctuations and shifts in the yield curve may cause losses.
Our primary interest rate exposures relate to our real estate securities, loans, floating rate debt obligations and interest rate
swaps. Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our business in a
number of ways. Changes in the general level of interest rates can affect our net interest income, which is the difference
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between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our
interest-bearing liabilities and hedges. Changes in the level of interest rates also can affect, among other things, our ability
to acquire real estate securities and loans at attractive prices, the value of our real estate securities, loans and derivatives and
our ability to realize gains from the sale of such assets.
In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may
increase and result in credit losses that would adversely affect our liquidity and operating results. Interest rates are highly
sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and
political conditions, and other factors beyond our control.
Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a significant
degree on our ability to obtain additional capital. Our financing strategy is dependent on our ability to place the match
funded debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities
widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be severely
restricted.
Interest rate changes may also impact our net book value as our real estate securities, real estate related loans and hedge
derivatives are marked to market each quarter. Debt obligations are not marked to market. Generally, as interest rates
increase, the value of our fixed rate securities decreases, which will decrease the book value of our equity.
Furthermore, shifts in the U.S. Treasury yield curve reflecting an increase in interest rates would also affect the yield
required on our real estate securities and therefore their value. For example, increasing interest rates would reduce the value
of the fixed rate assets we hold at the time because the higher yields required by increased interest rates result in lower
market prices on existing fixed rate assets in order to adjust the yield upward to meet the market, and vice versa. This
would have similar effects on our real estate securities portfolio and our financial position and operations to a change in
interest rates generally.
Our investments in real estate securities and loans are subject to changes in credit spreads, which could adversely
affect our ability to realize gains on the sale of such investments.
Real estate securities and loans are subject to changes in credit spreads. Credit spreads measure the yield demanded on
securities and loans by the market based on their credit relative to a specific benchmark.
Fixed rate securities and loans are valued based on a market credit spread over the rate payable on fixed rate U.S.
Treasuries of like maturity. Floating rate securities and loans are valued based on a market credit spread over LIBOR and
are affected similarly by changes in LIBOR spreads. Excessive supply of these securities combined with reduced demand
will generally cause the market to require a higher yield on these securities and loans, resulting in the use of a higher, or
"wider," spread over the benchmark rate to value such securities. Under such conditions, the value of our real estate
securities and loan portfolios would tend to decline. Conversely, if the spread used to value such securities were to
decrease, or "tighten," the value of our real estate securities portfolio would tend to increase. Such changes in the market
value of our real estate securities and loan portfolios may affect our net equity, net income or cash flow directly through
their impact on unrealized gains or losses on available for sale securities, and therefore our ability to realize gains on such
securities, or indirectly through their impact on our ability to borrow and access capital. During 2008 through the first
quarter of 2009, credit spreads widened substantially. This widening of credit spreads caused the net unrealized gains on
our securities, loans and derivatives, recorded in accumulated other comprehensive income or retained earnings, and
therefore our book value per share, to decrease and resulted in net losses.
In addition, if the value of our loans subject to financing agreements were to decline, it could affect our ability to refinance
such loans upon the maturity of the related repurchase agreements. Any credit or spread related losses incurred with respect
to our loans would affect us in the same way as similar losses on our real estate securities portfolio as described above.
In addition, widening credit spreads will generally result in a decrease in the mark to market value of certain investments
which are treated as derivatives on our balance sheet, such as total rate of return swaps. Since changes in the value of such
assets are reflected in our statements of operations, this would result in a decrease in our net income. Although we do not
have any, to the extent that we choose to make investments in real estate related assets by means of entering into total rate
of return swaps, our net income will be susceptible to decreases stemming from credit spread changes.
Any hedging transactions that we enter into may limit our gains or result in losses.
We use derivatives to hedge a portion of our interest rate exposure, and this approach has certain risks, including the risk
that losses on a hedge position will reduce the cash available for distribution to stockholders and that such losses may
exceed the amount invested in such instruments. We have adopted a general policy with respect to the use of derivatives,
which generally allows us to use derivatives where appropriate, but does not set forth specific policies and procedures or
require that we hedge any specific amount of risk. From time to time, we use derivative instruments, including forwards,
futures, swaps and options, in our risk management strategy to limit the effects of changes in interest rates on our
operations. A hedge may not be effective in eliminating all of the risks inherent in any particular position. Our profitability
may be adversely affected during any period as a result of the use of derivatives.
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There are limits to the ability of hedging strategy to protect us completely against interest rate risks. When rates change, we
expect the gain or loss on derivatives to be offset by a related but inverse change in the value of the items, generally our
liabilities, which we hedge. We cannot assure you, however, that our use of derivatives will offset the risks related to
changes in interest rates. We cannot assure you that our hedging strategy and the derivatives that we use will adequately
offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In addition, our hedging
strategy may limit our flexibility by causing us to refrain from taking certain actions that would be potentially profitable but
would cause adverse consequences under the terms of our hedging arrangements.
In managing our hedge instruments, we consider the effect of the expected hedging income on the REIT qualification tests
that limit the amount of gross income that a REIT may receive from hedging. The REIT provisions of the Internal Revenue
Code limit our ability to hedge. We need to carefully monitor, and may have to limit, our hedging strategy to assure that we
do not realize hedging income, or hold hedges having a value, in excess of the amounts which would cause us to fail the
REIT gross income and asset tests.
Accounting for derivatives under GAAP is extremely complicated. Any failure by us to account for our derivatives properly
in accordance with GAAP in our financial statements could adversely affect our earnings.
Under certain conditions, increases in prepayment rates can adversely affect yields on certain investments, including
our residential mortgage loans.
The value of our assets may be affected by prepayment rates on our residential mortgage loans and other floating rate
assets. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other
factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. In periods of
declining mortgage interest rates, prepayments on loans generally increase. If general interest rates decline as well, the
proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the
yields on the assets that were prepaid. In addition, the market value of floating rate assets may, because of the risk of
prepayment, benefit less than fixed rate assets from declining interest rates. Conversely, in periods of rising interest rates,
prepayments on loans generally decrease, in which case we would not have the prepayment proceeds available to invest in
assets with higher yields. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of
acquisition of certain investments.
In addition, when market conditions lead us to increase the portion of our CDO investments that are comprised of floating
rate securities, the risk of assets inside our CDOs prepaying increases. Since our CDO financing costs are locked in,
reinvestment of such prepayment proceeds at lower yields than the initial investments, as a result of changes in the interest
rate or credit spread environment, will result in a decrease of the return on our equity and therefore our net income.
Changes in accounting rules could occur at any time and could impact us in significantly negative ways that we are
unable to predict or protect against.
As has been widely publicized, the SEC and other regulatory bodies that establish the accounting rules applicable to us
have recently proposed or enacted a wide array of changes to current accounting rules. Moreover, these regulators may
propose additional changes in the future of which we are not currently aware. Changes to accounting rules that apply to us
could significantly impact our business or our reported financial performance in negative ways that we cannot predict or
prepare against. We cannot predict whether any changes to current accounting rules will occur or what impact any codified
changes will have on our business, results of operation or financial condition.
Environmental compliance costs and liabilities with respect to our real estate in which we have interests may
adversely affect our results of operations.
Our operating costs may be affected by our obligation to pay for the cost of complying with existing environmental laws,
ordinances and regulations, as well as the cost of complying with future legislation with respect to the assets, or loans
secured by assets, with environmental problems that materially impair the value of the assets. Under various federal, state
and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances on, under, or in such property. Such laws
often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous
or toxic substances. In addition, the presence of hazardous or toxic substances, or the failure to remediate properly, may
adversely affect the owner's ability to borrow by using such real property as collateral. Certain environmental laws and
common law principles could be used to impose liability for releases of hazardous materials, including asbestos-containing
materials, into the environment, and third parties may seek recovery from owners or operators of real properties for
personal injury associated with exposure to released asbestos-containing materials or other hazardous materials.
Environmental laws may also impose restrictions on the manner in which a property may be used or transferred or in which
businesses it may be operated, and these restrictions may require expenditures. In connection with the direct or indirect
ownership and operation of properties, we may be potentially liable for any such costs. The cost of defending against
claims of liability or remediating contaminated property and the cost of complying with environmental laws could
adversely affect our results of operations and financial condition.
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Risks Relating to Our REIT Status and Other Matters
Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our
stockholders.
We operate in a manner intended to qualify as a REIT for federal income tax purposes. Our ability to satisfy the asset tests
depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise
determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and
quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets
on an ongoing basis. Moreover, the proper classification of an instrument as debt or equity for federal income tax purposes,
and the tax treatment of participation interests that we hold in mortgage loans and mezzanine loans, may be uncertain in
some circumstances, which could affect the application of the REIT qualification requirements. Accordingly, there can be
no assurance that the IRS will not contend that our interests in subsidiaries or other issuers will not cause a violation of the
REIT requirements.
If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any
applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders
would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and
would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact
on the value of, and trading prices for, our stock. Unless entitled to relief under certain Internal Revenue Code provisions,
we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we ceased
to qualify as a REIT.
Our failure to qualify as a REIT would constitute an event of default under a significant number of our financings
and other agreements and would cause our common and preferred stock to be delisted from the NYSE.
Our failure to qualify as a REIT would constitute an event of default under a significant number of our financing and other
agreements, which would, in turn, result in either the acceleration of the amounts we owe to the applicable counterparty or
otherwise give our counterparty the right to terminate the applicable agreement. Either scenario would likely have a
material adverse effect on our financial condition and ability to conduct our business, which would likely, in turn, require
the Company to restructure or file for protection under the U.S. Bankruptcy Code.
In addition, the New York Stock Exchange requires, as a condition to the continued listing of our common and preferred
shares, that we maintain our REIT status. Consequently, if we fail to maintain our REIT status, our common and preferred
shares would promptly be delisted from the NYSE, which would decrease the trading activity of such shares. This could
make it difficult to sell shares and could cause the market volume of the shares trading to decline.
If Newcastle was delisted as a result of losing its REIT status and desired to relist its shares on the NYSE, the Company
would have to reapply to the NYSE to be listed as a domestic corporation. As the NYSE’s listing standards for REITs are
less onerous than its standards for domestic corporations, it would be more difficult for the Company to become a listed
company under these heightened standards. Given current conditions, Newcastle would not be able to satisfy the NYSE’s
listing standards for a domestic corporation. As a result, if it were delisted from the NYSE, it likely would not be able to
relist as a domestic corporation, and thus the Company’s common and preferred shares could not trade on the NYSE.
Dividends payable by REITs do not qualify for the reduced tax rates.
Tax law changes in 2003 reduced the maximum tax rate for dividends payable to individuals from 35% to 15% (through
2010). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although this legislation
does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular
corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be
relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely
affect the value of the stock of REITs, including our common stock. In addition, the relative attractiveness of real estate in
general may be adversely affected by the newly favorable tax treatment given to corporate dividends, which could affect the
value of our real estate assets negatively.
REIT distribution requirements could adversely affect our liquidity and our ability to execute our business plan.
We generally must distribute annually at least 90% of our net taxable income, excluding any net capital gain, in order for
corporate income tax not to apply to earnings that we distribute. We intend to make distributions to our stockholders to
comply with the requirements of the Internal Revenue Code. However, differences in timing between the recognition of
taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term
basis to meet the 90% distribution requirement of the Internal Revenue Code. Certain of our assets may generate substantial
mismatches between taxable income and available cash. As a result, the requirement to distribute a substantial portion of
our net taxable income could cause us to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms or
(iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt,
in order to comply with REIT requirements. Further, amounts distributed will not be available to fund investment activities.
If we fail to obtain debt or equity capital in the future, it could limit our ability to satisfy our liquidity needs, which could
adversely affect the value of our common stock.
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The IRS tax rules regarding recognizing capital losses and ordinary income for our non-recourse financings,
coupled with current REIT distribution requirements, could result in our recognizing significant taxable net income
without receiving an equivalent amount of cash proceeds from which to make required distributions. This
disconnect could have a serious, negative affect on us.
We may experience issues regarding the characterization of income for tax purposes. For example, we may recognize
significant ordinary income, which we would not be able to offset with capital losses, which could, in turn, increase the
amount of income we would be required to distribute to shareholders in order to maintain our REIT status. This could occur
in the case of one or more of our non-recourse financing structures, including off balance sheet structures such as our
subprime securitizations, where we incur capital losses on the related assets, and ordinary income from the cancellation of
the related non-recourse financing if the ultimate proceeds from the assets are insufficient to repay such debt. This could
also occur as a result of the repurchase of our outstanding debt at a discount as the gain recorded upon the cancellation of
indebtedness is characterized as ordinary income for tax purposes. During 2009, we repurchased $246.7 million face
amount of our outstanding CDO debt at a discount, and recorded $215.3 million of gain. In compliance with current tax
laws, we have the ability to defer the ordinary income recorded as a result of the cancellation of indebtedness to future
years and intend to defer all or a portion of such gain for 2009. While such deferral may postpone the effect of the
disconnect in the ability to offset taxable income and losses, it does not eliminate it.
If we experienced any of these disconnects, we may not have sufficient cashflow to make the distributions necessary to
satisfy our REIT distribution requirements, which would cause us to lose our REIT status and thereby materially negatively
impact our business, financial condition and potentially impair our ability to continue operating in the future. Under current
market conditions, this type of disconnect between taxable income and cash proceeds would be likely to occur at some
point in the future if the current regulations that create the disconnect are not revised, but we cannot predict at this time
when such a disconnect may occur.
We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay
distributions to our stockholders.
As a REIT, we are generally required to distribute at least 90% of our REIT taxable income (determined without regard to
the dividends paid deduction and not including net capital losses) each year to our stockholders. To qualify for the tax
benefits accorded to REITs, we intend to make distributions to our stockholders in amounts such that we distribute all or
substantially all our net taxable income each year, subject to certain adjustments. However, our ability to make distributions
may be adversely affected by the risk factors described herein, particularly in light of current market conditions. In the
event of a continued downturn in our operating results and financial performance relative to previous periods or continued
declines in the value of our asset portfolio, we may be unable to declare or pay quarterly distributions or make distributions
to our stockholders, and we may elect to comply with our REIT distribution requirements by, after completing various
procedural steps, distributing, under certain circumstances, up to 90% of the required amount in the form of common shares
in lieu of cash. The timing and amount of distributions are in the sole discretion of our board of directors, which considers,
among other factors, our earnings, financial condition, debt service obligations and applicable debt covenants, REIT
qualification requirements and other tax considerations and capital expenditure requirements as our board may deem
relevant from time to time.
The stock ownership limit imposed by the Internal Revenue Code for REITs and our charter may inhibit market
activity in our stock and restrict our business combination opportunities.
In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of our
outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue
Code to include certain entities) at any time during the last half of each taxable year after our first year. Our charter, with
certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable to preserve our
qualification as a REIT. Unless exempted by our board of directors, no person may own more than 8% of the aggregate
value of our outstanding capital stock, treating classes and series of our stock in the aggregate, or more than 25% of the
outstanding shares of our Series B Preferred Stock, Series C Preferred Stock or our Series D Preferred Stock. Our board
may grant an exemption in its sole discretion, subject to such conditions, representations and undertakings as it may
determine in its sole discretion. These ownership limits could delay or prevent a transaction or a change in our control that
might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. Our board has
granted limited exemptions to an affiliate of our manager, a third party group of funds managed by Cohen & Steers, and
certain affiliates of these entities.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our
income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result
of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes. Moreover, if a
REIT distributes less than 85% of its taxable income to its stockholders during any calendar year (including any
distributions declared by the last day of the calendar year but paid in the subsequent year), then it is required to pay an
excise tax on 4% of any shortfall between the required 85% and the amount that was actually distributed. Any of these
taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification
24
requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property
or inventory, we may hold some of our assets through taxable REIT subsidiaries. Such subsidiaries will be subject to
corporate level income tax at regular rates.
Complying with REIT requirements may cause us to forego otherwise attractive opportunities.
To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the
sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the
ownership of our stock. We also may be required to make distributions to stockholders at disadvantageous times or when
we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our
ability to make certain attractive investments.
Complying with REIT requirements may limit our ability to hedge effectively.
The existing REIT provisions of the Internal Revenue Code may substantially limit our ability to hedge our operations
because a significant amount of the income from those hedging transactions is likely to be treated as non-qualifying income
for purposes of both REIT gross income tests. In addition, we must limit our aggregate income from non-qualified hedging
transactions, from our provision of services and from other non-qualifying sources, to less than 5% of our annual gross
income (determined without regard to gross income from qualified hedging transactions). As a result, we may have to limit
our use of certain hedging techniques or implement those hedges through total return swaps. This could result in greater
risks associated with changes in interest rates than we would otherwise want to incur or could increase the cost of our
hedging activities. If we fail to comply with these limitations, we could lose our REIT qualification for U.S. federal income
tax purposes, unless our failure was due to reasonable cause and not due to willful neglect, and we meet certain other
technical requirements. Even if our failure was due to reasonable cause, we might incur a penalty tax.
The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur, and may limit the
manner in which we effect future securitizations.
Certain of our securitizations have resulted in the creation of taxable mortgage pools for federal income tax purposes. As a
REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would generally not be adversely
affected by the characterization of the securitization as a taxable mortgage pool. Certain categories of stockholders,
however, such as foreign stockholders eligible for treaty or other benefits, stockholders with net operating losses, and
certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a
portion of their dividend income from us that is attributable to the taxable mortgage pool. In addition, to the extent that our
stock is owned by tax-exempt “disqualified organizations,” such as certain government-related entities and charitable
remainder trusts that are not subject to tax on unrelated business income, we may incur a corporate level tax on a portion of
our income from the taxable mortgage pool. In that case, we may reduce the amount of our distributions to any disqualified
organization whose stock ownership gave rise to the tax.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
We conduct our operations so as not to become regulated as an investment company under the Investment Company Act of
1940, as amended. We believe that there are a number of exemptions under the Investment Company Act that may be
applicable to us. The assets that we may acquire, therefore, are limited by the provisions of the Investment Company Act
and the rules and regulations promulgated under the Investment Company Act. In addition, we could, among other things,
be required either (a) to change the manner in which we conduct our operations to avoid being required to register as an
investment company or (b) to register as an investment company, either of which could adversely affect us and the market
price for our stock.
ERISA may restrict investments by plans in our common stock.
A plan fiduciary considering an investment in our common stock should consider, among other things, whether such an
investment is consistent with the fiduciary obligations under ERISA, including whether such investment might constitute or
give rise to a prohibited transaction under ERISA, the Internal Revenue Code or any substantially similar federal, state or
local law and, if so, whether an exemption from such prohibited transaction rules is available.
Maryland takeover statutes may prevent a change of our control. This could depress our stock price.
Under Maryland law, "business combinations" between a Maryland corporation and an interested stockholder or an affiliate
of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder
becomes an interested stockholder. These business combinations include certain mergers, consolidations, share exchanges,
or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities or a
liquidation or dissolution. An interested stockholder is defined as:
•
•
any person who beneficially owns 10% or more of the voting power of the corporation's outstanding shares; or
an affiliate or associate of a corporation who, at any time within the two-year period prior to the date in
question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the
corporation.
A person is not an interested stockholder under the statute if the board of directors approved in advance the transaction by
which he or she otherwise would have become an interested stockholder.
25
After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder
generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at
least:
•
•
80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation voting
together as a single group; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held
by the interested stockholder with whom or with whose affiliate the business combination is to be effected or
held by an affiliate or associate of the interested stockholder voting together as a single voting group.
The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of
consummating any offer, including potential acquisitions that might involve a premium price for our common stock or
otherwise be in the best interest of our stockholders.
Our authorized, but unissued common and preferred stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock. In
addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock and may
set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board may establish a
series of preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price
for our common stock or otherwise be in the best interest of our stockholders.
Our stockholder rights plan could inhibit a change in our control.
We have adopted a stockholder rights agreement. Under the terms of the rights agreement, in general, if a person or group
acquires more than 15% of the outstanding shares of our common stock, all of our other common stockholders will have the
right to purchase securities from us at a discount to such securities' fair market value, thus causing substantial dilution to the
acquiring person. The rights agreement may have the effect of inhibiting or impeding a change in control not approved by
our board of directors and, therefore, could adversely affect our stockholders' ability to realize a premium over the then-
prevailing market price for our common stock in connection with such a transaction. In addition, since our board of
directors can prevent the rights agreement from operating, in the event our board approves of an acquiring person, the rights
agreement gives our board of directors significant discretion over whether a potential acquirer's efforts to acquire a large
interest in us will be successful. Because the rights agreement contains provisions that are designed to assure that the
executive officers, our manager and its affiliates will never, alone, be considered a group that is an acquiring person, the
rights agreement provides the executive officers, our manager and its affiliates with certain advantages under the rights
agreement that are not available to other stockholders.
Our staggered board and other provisions of our charter and bylaws may prevent a change in our control.
Our board of directors is divided into three classes of directors. Directors of each class are chosen for three-year terms upon
the expiration of their current terms, and each year one class of directors is elected by the stockholders. The staggered terms
of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer
or change in control might be in the best interest of our stockholders. In addition, our charter and bylaws also contain other
provisions that may delay or prevent a transaction or a change in control that might involve a premium price for our
common stock or otherwise be in the best interest of our stockholders.
Risks Related to Our Common Shares
Our share price has fluctuated meaningfully, particularly on a percentage basis, and may fluctuate meaningfully in
the future. Accordingly, you may not be able to resell your shares at or above the price at which you purchased
them.
The trading price of our common shares has recently been volatile. Moreover, future share price fluctuations could likely
be subject to similarly wide price fluctuations in the future in response to various factors, including:
• market conditions in the broader stock market in general, or in the REIT or real estate industry in particular;
• market perception of our current and projected financial condition, potential growth, future earnings and
future cash dividends;
•
actual or anticipated fluctuations in our quarterly financial and operating results;
• market perception or media coverage of our manager or its affiliates;
•
•
•
actions by rating agencies;
short sales of our common stock;
issuance of new or changed securities analysts’ reports or recommendations;
26
• media coverage of us, other REITs or the outlook of the real estate industry;
• major reductions in trading volumes on the exchanges on which we operate;
•
•
credit deterioration within our portfolio;
legislative or regulatory developments, including changes in the status of our regulatory approvals or licenses;
and
•
litigation and governmental investigations.
These and other factors may cause the market price and demand for our common shares to fluctuate substantially, which
may negatively affect the price or liquidity of our common shares. Moreover, the recent market conditions have negatively
impacted our share price and may do so in the future. When the market price of a stock has been volatile or has decreased
significantly in the past, holders of that stock have, at times, instituted securities class action litigation against the company
that issued the stock. If any of our shareholders brought a lawsuit against us, we could incur substantial costs defending,
settling or paying any resulting judgments related to the lawsuit. Such a lawsuit could also divert the time and attention of
our management from our business and hurt our share price.
We may be unable – or elect not – to pay dividends on our common or preferred shares in the future, which would
negatively impact our business in a number of ways and decrease the price of our common and preferred shares.
We did not pay dividends on our common stock for the fourth fiscal quarter of 2008 or any of the four fiscal quarters of
2009. While we are required to make distributions in order to maintain our REIT status (as described above under “–We
may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay distributions to our
stockholders”), we may elect not to maintain our REIT status, in which case we would no longer be required to make such
distributions. Moreover, even if we do elect to maintain our REIT status, we may elect to comply with the applicable
requirements by, after completing various procedural steps, distributing, under certain circumstances, up to 90% of the
required amount in the form of common shares in lieu of cash. If we elect not to maintain our REIT status or to satisfy any
required distributions in common shares in lieu of cash, such action could negatively affect our business and financial
condition as well as the price of both our common and preferred shares. No assurance can be given that we will pay any
dividends on our common shares in the future.
In addition, in the fourth fiscal quarter of 2008 and in 2009, our board of directors elected not to declare any of the specified
dividends on our three series of preferred stock. Until we pay all accrued dividends on our preferred shares, we cannot pay
any dividends on our common shares, pay any consideration to repurchase or otherwise acquire shares of our common
stock or redeem any shares of any series of our preferred stock without redeeming all of our outstanding preferred shares in
accordance with the governing documentation. Consequently, the failure to pay dividends on our preferred shares restricts
the actions that we may take with respect to our common shares and preferred shares. Moreover, if we do not pay dividends
on any series of preferred stock for six or more periods, then holders of each affected series obtain the right to call a special
meeting and elect two members to our board of directors. Our failure to make dividend payments for the January 31,
April 30, July 31, October 31, 2009 as well as the January 31, 2010 dividend payment dates counts as five quarterly periods
of non-payment towards the potential triggering of this right. Thus, if we do not make a dividend payment on our preferred
stock by April 30, 2010, the holders of our preferred stock will then be entitled to call a meeting to elect two directors to
our board of directors. We cannot predict whether the holders of our preferred stock would take such action or, if taken,
how long the process would take or what impact the two new directors on our board of directors would have on our
company (other than increasing our director compensation costs). However, the election of additional directors would
affect the composition of our board of directors and, thus, could affect the management of our business.
Shares eligible for future sale may adversely affect our common stock price.
Sales of our common stock or other securities in the public or private market, or the perception that these sales may occur,
could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital
through the sale of our equity securities. Under our certificate of incorporation, we are authorized to issue up to
500,000,000 shares of common stock, of which 52,912,513 shares of common stock were outstanding as of December 31,
2009. We cannot predict the size of future issuances of our common stock or other securities or the effect, if any, that
future sales and issuances would have on the market price of our common stock.
An increase in market interest rates may have an adverse effect on the market price of our common stock.
One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our
distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common stock
is based primarily on the earnings and return that we derive from our investments and income with respect to our
investments and our related distributions to stockholders, and not from the market value of the investments themselves,
then interest rate fluctuations and capital market conditions will likely affect the market price of our common stock. For
instance, if market interest rates rise without an increase in our distribution rate, the market price of our common stock
could decrease as potential investors may require a higher distribution yield on our common stock or seek other securities
paying higher distributions or interest. In addition, rising interest rates would result in increased interest expense on our
variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay distributions.
27
Item 1B. Unresolved Staff Comments
We have no unresolved staff comments received more than 180 days prior to December 31, 2009.
Item 2. Properties.
As of December 31, 2009, we have no material investments in properties.
Our manager leases principal executive and administrative offices located at 1345 Avenue of the Americas, New York,
New York 10105. Its telephone number is (212) 798-6100.
Item 3. Legal Proceedings.
We are not a party to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of our security holders during the fourth quarter of 2009.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity
Securities.
Our common stock has been listed and is traded on the New York Stock Exchange (NYSE) under the symbol “NCT” since
our initial public offering in October 2002. The following table sets forth, for the periods indicated, the high, low and last
sale prices in dollars on the NYSE for our common stock and the distributions we declared with respect to the periods
indicated.
2009
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$0.95
$1.25
$3.94
$3.25
2008
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$13.70
$10.66
$8.20
$6.34
Low
$0.25
$0.55
$0.49
$1.30
Low
$7.50
$6.88
$4.02
$0.15
Last Sale
$0.65
$0.66
$2.97
$2.09
Last Sale
$8.26
$7.01
$6.35
$0.84
Distributions
Declared
$ -
$ -
$ -
$ -
Distributions
Declared
$0.25
$0.25
$0.25
$ -
We may declare quarterly distributions on our common stock. No assurance, however, can be given that any future
distributions will be made or, if made, as to the amounts or timing of any future distributions as such distributions are
subject to our earnings, financial condition, liquidity, capital requirements, REIT requirements and such other factors as our
board of directors deems relevant. As described under Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Market Considerations,” we recently elected not to declare quarterly dividends on
either our common or preferred shares.
On February 17, 2010, the closing sale price for our common stock, as reported on the NYSE, was $2.30. As of February
17, 2010, there were approximately 92 record holders of our common stock. This figure does not reflect the beneficial
ownership of shares held in nominee name.
28
Equity Compensation Plan Information
The following table summarizes the total number of outstanding securities in the incentive plan and the number of
securities remaining for future issuance, as well as the weighted average exercise price of all outstanding securities as of
December 31, 2009.
Number of Securities to be
Issued Upon Exercise of
Outstanding Options
Weighted Average
Exercise Price of
Outstanding Options
Number of Securities Remaining
Available for Future Issuance
Under Equity Compensation
Plans
Plan Category
Equity Compensation Plans Approved
by Security Holders:
Newcastle Investment Corp. Nonqualified
Stock Option and Incentive Award Plan
2,498,609 (1)
$26.64
6,367,917 (2)
Equity Compensation Plans Not Approved
by Security Holders:
None
N/A
N/A
N/A
(1)
(2)
Includes options for (i) 1,686,447 shares held by an affiliate of our manager; (ii) 798,162 shares granted to our
manager and assigned to certain of the manager’s employees; and (iii) an aggregate of 14,000 shares held by our
directors, other than Mr. Edens.
The maximum available for issuance is equal to 10% of the number of outstanding equity interests, subject to a
maximum of 10,000,000 shares in the aggregate over the term of the plan. The number of securities remaining
available for future issuance is net of an aggregate of 90,356 shares of our common stock awards to our directors,
other than Mr. Edens and Mr. Riis, representing the aggregate annual automatic stock awards to each such director
for 2003 through 2009, and of 1,043,118 shares issued to our manager, certain of our directors, and employees of our
manager upon the exercise of previously granted options.
29
Item 6. Selected Financial Data.
The selected historical consolidated financial information set forth below as of and for each of the five years ended
December 31, 2009 has been derived from our audited historical consolidated financial statements.
The information below should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included in Part
II, Item 8, “Financial Statements and Supplementary Data.”
Selected Consolidated Financial Information
(in thousands, except per share data)
Operating Data
Interest income
Interest expense
Net interest income
Impairment
2009
Year Ended December 31,
2007
2008
2006
2005
$
361,866
218,410
143,456
$
468,867
307,303
161,564
$
680,535
476,932
203,603
$
529,818
374,269
155,549
$
348,502
226,195
122,307
548,540
2,991,830
220,321
13,565
8,421
Net interest income (loss) after impairment
(405,084)
(2,830,266)
(16,718)
141,984
113,886
Other income (loss)
Other expenses
227,399
31,901
(112,809)
32,623
(8,885)
39,724
23,660
38,172
28,562
31,124
Income (loss) from continuing operations
Income (loss) from discontinued operations
Net income (loss)
Preferred dividends
Income (loss) applicable to common stockholders
(209,586)
(318)
(209,904)
(13,501)
(223,405)
$
(2,975,698)
(9,654)
(2,985,352)
(13,501)
(2,998,853)
$
(65,327)
(130)
(65,457)
(12,640)
(78,097)
$
127,472
451
127,923
(9,314)
118,609
$
111,324
5,631
116,955
(6,684)
110,271
$
Net income (loss) per share of common stock, diluted
$
(4.23)
$
(56.81)
$
(1.52)
$
2.67
$
2.51
Income (loss) from continuing operations per share of common
stock, after preferred dividends, diluted
$
(4.22)
$
(56.63)
$
(1.52)
$
2.66
$
2.38
Weighted average number of shares of common stock
outstanding, diluted
52,864
52,785
51,369
44,417
43,986
Dividends declared per share of common stock
$
-
$
0.750
$
2.850
$
2.615
$
2.500
Balance Sheet Data
Real estate securities, available for sale
Real estate related loans, net
Residential mortgage loans, net
Operating real estate, net
Cash and cash equivalents
Total assets
Debt
Total liabilities
Common stockholders' equity (deficit)
Preferred stock
Supplemental Balance Sheet Data
Common shares outstanding
2009
2008
As Of December 31,
2007
2006
2005
$
1,830,795
573,862
383,647
9,966
68,300
3,514,628
4,940,204
5,155,280
(1,793,152)
152,500
$
1,668,748
843,212
409,632
11,866
49,746
3,473,623
5,515,199
5,867,155
(2,546,032)
152,500
$
4,835,884
1,856,978
634,605
34,399
55,916
8,037,770
7,391,694
7,590,145
295,125
152,500
$
5,581,228
1,568,916
809,097
29,626
5,371
8,604,392
7,504,731
7,602,412
899,480
102,500
$
4,554,519
615,551
600,682
16,673
21,275
6,209,699
5,212,358
5,291,696
815,503
102,500
52,913
52,789
52,779
45,714
43,913
Book value (deficit) per share of common stock
$
(33.89)
$
(48.23)
$
5.59
$
19.68
$
18.57
30
2009
2008
2007
2006
2005
Year Ended December 31,
Other Data
Cash Flow provided by (used in):
Operating activities
Investing activities
Financing activities
Adjusted Funds from Operations (AFFO) (1)
Net interest income less expenses (net of preferred dividends) (2)
$
84,163
$
118,174
$
(6,510)
$
16,322
$
98,763
206,431
(272,040)
(223,529)
98,054
1,692,712
(1,817,056)
(3,004,076)
115,440
33,972
23,083
(76,976)
151,239
(1,963,058)
(1,334,746)
1,930,832
1,219,347
119,421
108,063
104,031
84,499
(1) We believe AFFO is one appropriate measure of the operating performance of real estate companies. We also believe that AFFO is an
appropriate supplemental disclosure of operating performance for a REIT. Furthermore, AFFO is used to compute our incentive compensation
to our manager. AFFO, for our purposes, represents net income available for common stockholders (computed in accordance with GAAP),
excluding extraordinary items, plus depreciation of our operating real estate, and after adjustments for unconsolidated subsidiaries, if any. We
consider gains and losses on resolution of our investments to be a normal part of our recurring operations and, therefore, do not exclude such
gains and losses when arriving at AFFO. This is the one difference between our definition of AFFO and the National Association of Real
Estate Investment Trusts (“NAREIT”) definition of FFO, which excludes gains and losses. Adjustments for unconsolidated subsidiaries, if any,
are calculated to reflect AFFO on the same basis. AFFO does not represent cash generated from operating activities in accordance with GAAP
and therefore should not be considered an alternative to net income as an indicator of our operating performance or as an alternative to cash
flow as a measure of our liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of AFFO may be
different from the calculation used by other companies and, therefore, comparability may be limited.
(2) We believe that net interest income less expenses (net of preferred dividends) is an appropriate supplemental disclosure of the operating
performance for a mortgage REIT. Net interest income less expenses (net of preferred dividends) does not represent cash generated from
operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indicator of our
operating performance or as an alternative to cash flow as a measure of our liquidity and is not necessarily indicative of cash available to fund
cash needs. Our calculation of net interest income less expenses (net of preferred dividends) may be different from the calculation used by
other companies and, therefore, comparability may be limited.
Year Ended December 31,
2009
2008
2007
2006
2005
Calculation of Adjusted Funds From Operations (AFFO):
Income (loss) applicable to common stockholders
$
(223,405)
$
(2,998,853)
$
(78,097)
$
118,609
$
110,271
Operating real estate depreciation
Accumulated depreciation on operating real estate sold
-
(124)
-
(5,223)
1,121
-
812
-
702
(6,942)
Adjusted Funds from operations (AFFO)
$
(223,529)
$
(3,004,076)
$
(76,976)
$
119,421
$
104,031
Calculation of Net Interest Income Less Expenses (Net
of Preferred Dividends):
Income (loss) applicable to common stockholders
Add (Deduct):
Impairment
Other (income) loss
Loss from discontinued operations
Year Ended December 31,
2009
2008
2007
2006
2005
$
(223,405)
$
(2,998,853)
$
(78,097)
$
118,609
$
110,271
548,540
(227,399)
318
98,054
$
2,991,830
112,809
9,654
115,440
$
220,321
8,885
130
151,239
$
13,565
(23,660)
(451)
108,063
$
8,421
(28,562)
(5,631)
84,499
$
31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following should be read in conjunction with our consolidated financial statements and notes thereto included in Part
II, Item 8, “Financial Statements and Supplementary Data,” and Part I, Item 1A, “Risk Factors.”
General
Newcastle Investment Corp. is a real estate investment and finance company. We invest in, and actively manage, a
portfolio of real estate securities, loans and other real estate related assets. Our objective is to maximize the difference
between the yield on our investments and the cost of financing these investments while hedging our interest rate risk. We
emphasize portfolio management, asset quality, liquidity, diversification, match funded financing and credit risk
management.
We currently own a diversified portfolio of credit sensitive real estate debt investments, including securities and loans. Our
portfolio of real estate securities includes commercial mortgage backed securities (CMBS), senior unsecured debt issued by
property REITs, real estate related asset backed securities (ABS) and FNMA/FHLMC securities. Mortgage backed
securities are interests in or obligations secured by pools of mortgage loans. We generally target investments rated A
through BB, except for our FNMA/FHLMC securities which have an implied AAA rating. We also own, directly and
indirectly, interests in loans and pools of loans, including real estate related loans, commercial mortgage loans, residential
mortgage loans, manufactured housing loans and subprime mortgage loans.
We employ leverage as part of our investment strategy. We do not have a predetermined target debt to equity ratio as we
believe the appropriate leverage for the particular assets we are financing depends on the credit quality of those assets. As a
result of our negative GAAP equity, our GAAP debt to equity ratio is not a meaningful measure as of December 31, 2009.
Our general investment guidelines adopted by our board of directors limit total leverage (as defined under the governing
documents) to a maximum 9.0 to 1 debt to equity ratio. As of December 31, 2009, our debt to equity ratio, as computed
under this methodology, was approximately 4.2 to 1. We utilize leverage for the sole purpose of financing our portfolio and
not for the purpose of speculating on changes in interest rates.
We strive to maintain access to a broad array of capital resources in an effort to insulate our business from potential
fluctuations in the availability of capital. We utilize multiple forms of financing including collateralized debt obligations
(CDOs), other securitizations, term loans, and trust preferred securities, as well as short term financing in the form of loans
and repurchase agreements. As we discuss in more detail under “– Market Considerations” below, the continued
challenging credit and liquidity conditions have limited the array of capital resources available to us and made the terms of
capital resources we are able to obtain less favorable to us relative to the terms we were able to obtain prior to the onset of
challenging conditions. For example, we are currently contractually restricted from entering into new debt financings
subject to margin calls other than to finance up to a specified amount of FNMA/FHLMC securities.
We seek to match fund our investments with respect to interest rates and maturities in order to reduce the impact of interest
rate fluctuations on earnings and reduce the risk of refinancing our liabilities prior to the maturity of the investments. We
seek to finance a substantial portion of our real estate securities and loans through the issuance of term debt, which
generally represents obligations issued in multiple classes secured by an underlying portfolio of assets. Specifically, our
CDO financings offer us the structural flexibility to buy and sell certain investments to manage risk and, subject to certain
limitations, to optimize returns.
We conduct our business through four primary segments: (i) investments financed with non-recourse collateralized debt
obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments financed with recourse debt,
including FNMA / FHLMC securities, and (iv) unlevered investments. Revenues attributable to each segment are disclosed
below (unaudited) (in thousands).
For the Year Ended
December 31, 2009
December 31, 2008
December 31, 2007
CDOs
$
$
$
275,938
307,891
382,642
Other Non-
Recourse
76,868
88,643
98,255
$
$
$
Recourse
$
7,416
$
47,707
$
160,605
Taxation
Unlevered Unallocated
$
$
$
$
$
$
1,543
22,672
37,297
101
1,954
1,736
Total
361,866
468,867
680,535
$
$
$
We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as
amended (the "Code"), and we intend to continue to operate in such a manner. Our current and continuing qualification as
a REIT depends on our ability to meet various tax law requirements, including, among others, requirements relating to the
sources of our income, the nature of our assets, the composition of our stockholders, and the timing and amount of
distributions that we make. REIT distribution requirements may generally be satisfied up to 90% through stock dividends
rather than cash, subject to limitations based on the value of the stock.
32
As a REIT, we will generally not be subject to U.S. federal corporate income tax on that portion of our income that is
distributed to stockholders if we distribute at least 90% of our REIT taxable income to our stockholders by prescribed dates
and comply with various other requirements. We may, however, nevertheless be subject to certain state, local and foreign
income and other taxes, and to U.S. federal income and excise taxes and penalties in certain situations, including taxes on
our undistributed income. In addition, our stockholders may be subject to state, local or foreign taxation in various
jurisdictions, including those in which they transact business or reside. The state, local and foreign tax treatment of us and
our stockholders may not conform to the U.S. federal income tax treatment.
If, in any taxable year, we fail to satisfy one or more of the various tax law requirements, we could fail to qualify as a REIT.
If we fail to qualify as a REIT for a particular tax year, our income in that year would be subject to U.S. federal corporate
income tax (including any applicable alternative minimum tax), and we may need to borrow funds or liquidate certain
investments in order to pay the applicable tax, or we may not be able to pay it. Unless entitled to relief under certain
statutory provisions, we would also be disqualified from treatment as a REIT for the four taxable years following the year
during which qualification is lost. Moreover, if we fail to qualify as a REIT, we would be delisted from the NYSE.
Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic,
market, legal, tax or other developments may cause us to fail to qualify as a REIT, or may cause our board of directors to
revoke the REIT election, including certain potential developments discussed in Part I, Item 1A, “Risk Factors.”
Market Considerations
Financial Markets in which We Operate
Our ability to generate income is dependent on our ability to invest our capital on a timely basis at attractive levels. The
two primary market factors that affect this ability are (1) credit spreads and (2) the availability of financing on favorable
terms.
Generally speaking, widening credit spreads reduce any unrealized gains on our current investments (or cause or increase
unrealized losses) and increase our costs for new financings, but increase the yields available on potential new investments,
while tightening credit spreads increase the unrealized gains (or reduce unrealized losses) on our current investments and
reduce our costs for new financings, but reduce the yields available on potential new investments. By reducing unrealized
gains (or causing unrealized losses), widening credit spreads also impact our ability to realize gains on existing investments
if we were to sell such assets.
During 2009, credit spreads widened initially and then tightened substantially. This tightening of credit spreads caused the
net unrealized losses on our securities and derivatives to decrease. One of the key drivers of the widening of credit spreads
over the past several years has been the continued disruption and liquidity concerns throughout the credit markets. The
severity and scope of the disruption intensified meaningfully during the fourth quarter of 2008 and the first quarter of 2009.
In the latter part of 2009, credit spreads tightened substantially. Despite signs of moderate improvement, market conditions
remain significantly challenging, could change rapidly, and we do not know how recent or future changes in market
conditions will affect our business.
Liquidity
The continued challenging credit and liquidity conditions have adversely affected us and the markets in which we operate
in a number of other ways. For example, it has reduced the market trading activity for many real estate securities and loans,
resulting in less liquid markets for those securities and loans. As the securities held by us and many other companies in our
industry are marked to market at the end of each quarter, the decreased liquidity and concern over market conditions have
resulted in significant reductions in mark to market valuations of many real estate securities and loans and the collateral
underlying them. These lower valuations, and decreased expectations of future cash flows, have affected us by, among
other things:
•
•
•
•
•
decreasing our net book value;
contributing to our decision to record significant impairment charges;
prompting us to negotiate the removal of certain financial covenants from our non-CDO financings;
reducing the amount, which we refer to as cushion, by which we satisfy the over collateralization and interest
coverage tests of our CDOs (sometimes referred to as CDO “triggers”) or contributing to several of our CDOs
failing their over collateralization tests (see “– Liquidity and Capital Resources” and “– Debt Obligations”
below); and
requiring us to pay additional amounts under certain financing arrangements.
In some cases, we have sold, and may continue to sell, assets at prices below what we believed to be their value in order to
meet liquidity requirements under certain financing arrangements. Failed CDO triggers, impairments resulting from
incurred losses, and asset sales at prices significantly below face amount, while the related debt is being repaid at its full
33
face amount, further contribute to reductions in future earnings, cash flow and liquidity. As a result, we expect that our cash
flow from operations will be significantly reduced relative to previous years.
In order to maintain liquidity in 2008 and 2009, we elected to retain the majority of our investment proceeds (including
those from asset sales) in lieu of using those proceeds to make new investments and elected not to declare any common or
preferred dividends during the fourth quarter of 2008 or all of 2009. This approach has increased our liquidity while
reducing our operating earnings. We may elect to adjust or not to pay any future dividend payments to reflect our current
and expected cash from operations or to satisfy future liquidity needs.
In addition, we note that the recent reduction in the number of financial institutions has impacted our liquidity options and
sources of capital. The consolidation or elimination of Lehman Brothers, Bear Stearns and several other counterparties has
increased our concentration of counterparty risk, decreased the universe of potential counterparties and reduced our ability
to obtain competitive financing rates and terms. For a more detailed discussion of our counterparty default and
concentration risk, see Part I, Item 1A, “Risk Factors – Risks Related to the Financial Services Industry and Financial
Markets – We are subject to counterparty default and concentration risk.”
Extent of Market Disruption
We do not currently know the full extent to which this market disruption will affect us or the markets in which we operate,
and we are unable to predict its length or ultimate severity. If the disruption continues, particularly with respect to
commercial real estate, we will likely experience additional impairment charges, potential reductions in cash flows from
our investments and additional challenges in raising capital and obtaining investment or other financing on attractive terms.
Moreover, we will likely need to continue to place a high priority on managing our liquidity. If we raised capital or issued
unsecured debt in the current market, it would be significantly dilutive to our current shareholders. Certain aspects of these
effects are more fully described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations – Interest Rate, Credit and Spread Risk” and “– Liquidity and Capital Resources” as well as in Part
II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
Formation and Organization
We were formed in 2002 as a subsidiary of Newcastle Investment Holdings Corp. (referred to herein as Holdings). Prior to
our initial public offering, Holdings contributed to us certain assets and liabilities in exchange for approximately 16.5
million shares of our common stock. Our operations commenced in July 2002. In May 2003, Holdings distributed to its
stockholders all of the shares of our common stock that it held, and it no longer owns any of our common equity.
The following table presents information on shares of our common stock issued since our formation:
Year
Shares Issued
Range of Issue
Prices (1)
Net Proceeds
(millions)
Formation - 2004
2005
2006
2007
2008
2009
December 31, 2009
39,859,481
4,053,928
1,800,408
7,065,362
9,871
123,463
52,912,513
$29.60
$29.42
$27.75-$31.30
N/A
N/A
$108.2
$51.2
$201.3
$0.1
$0.1
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors.
As of December 31, 2009, approximately 3.8 million of our shares of common stock were held by our manager, through its
affiliates, and principals of Fortress. In addition, our manager, through its affiliates, held options to purchase approximately
1.7 million shares of our common stock at December 31, 2009.
Application of Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated
financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles
(“GAAP”). The preparation of financial statements in conformity with GAAP requires the use of estimates and
assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities
and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Management believes
that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and
reasonable. Actual results have been in line with Management’s estimates and judgements used in applying each of the
accounting policies described below. A summary of our significant accounting policies is presented in Note 2 to our
consolidated financial statements, which appear in Part II, Item 8, “Financial Statements and Supplementary Data.” The
following is a summary of our accounting policies that are most effected by judgments, estimates and assumptions.
34
Variable Interest Entities
Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only
its primary beneficiary, which is defined as the party who will absorb a majority of the VIE’s expected losses or receive a
majority of the expected residual returns as a result of holding variable interests.
The VIEs in which we have a significant interest include (i) our subprime securitizations, which are held in qualifying
special purpose entities and are therefore exempt from consolidation as VIEs through December 31, 2009, (ii) our CDOs, in
which we have been determined to be the primary beneficiary and therefore consolidate them, since we would absorb a
majority of their expected losses and receive a majority of their expected residual returns, as determined on the date of
formation and on any applicable reconsideration dates, and (iii) our manufactured housing loan financing structures, which
are similar to the CDOs in analysis. Our CDOs and manufactured housing loan financings are held in special purpose
entities whose debt is treated as a non-recourse secured borrowing of Newcastle. Under certain circumstances, if our
economic interest in any such structure were to become negligible, or if we lost our rights to control, we might be required
to deconsolidate the related entity. In addition, our investments in securities may be deemed to be variable interests in VIEs,
depending on their structure. We monitor these investments and, to the extent we determine we own the majority of the
currently controlling class, analyze them for potential consolidation.
We will continue to analyze future investments, as well as reconsideration events in existing entities, pursuant to the VIE
requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE since they
involve estimated probability weighting of subjectively determined possible cash flow scenarios. The result could be the
consolidation of an entity that would otherwise not have been consolidated or the non-consolidation of an entity that would
otherwise have been consolidated.
Valuation and Impairment of Securities
We have classified all our real estate securities as available for sale. As such, they are carried at fair value with net
unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment
losses are considered temporary as described below. Fair value may be based upon broker quotations, counterparty
quotations or pricing services quotations, which provide valuation estimates based upon reasonable market order
indications or a good faith estimate thereof and are subject to significant variability based on market conditions, such as
interest rates, credit spreads and market liquidity. A significant portion of our securities are currently not traded in active
markets and therefore have little or no price transparency. For a further discussion of this trend, see “– Market
Considerations” above. As a result, we have estimated the fair value of these illiquid securities based on internal pricing
models rather than broker quotations. The determination of estimated cash flows used in pricing models is inherently
subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology used to
determine fair value, could result in a significant and immediate increase or decrease in our book equity. For securities
valued with pricing models, these inputs include the discount rate, assumptions relating to prepayments, default rates and
loss severities, as well as other variables.
See Note 7 to our consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary Data” for
information regarding the fair value of our investments, and its estimation methodology, as of December 31, 2009.
Our estimation of the fair value of level 3B assets (as described below) involves significant judgment. Changes in market
conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant
increase or decrease in our book equity. For securities valued using pricing models, the inputs include the discount rate,
assumptions relating to prepayments, default rates and loss severities, as well as other variables. We validated the inputs
and outputs of our models by comparing them to available independent third party market parameters and models for
reasonableness. We believe the assumptions we used are within the range that a market participant would use and factor in
the relative illiquidity currently in the markets. In comparison to the prior year end, we have used slower prepayment
speeds, higher default rates and higher severity assumptions as inputs to our pricing models in order to reflect current
market conditions. In 2008 and 2009, Newcastle generally lowered the prepayment assumptions based on observed
reductions in actual prepayment speeds and slower expected future prepayments consistent with market projections. The
slower prepayments were the result of increasing difficulties for borrowers to refinance, caused by a tightening of
underwriting standards, decline in home prices, contraction of available lenders due to bank failures and a distressed
securitization market. Default assumptions were increased due to higher levels of delinquent underlying loans. Loss
severity assumptions were increased based on observed increases in recent loss severities that have been driven by falling
home prices and the increasing number of foreclosures or distressed home sales in the residential sector and higher losses as
a result of the increasing number of foreclosures and bankruptcies of borrowers experienced in the commercial sector. The
discount rate assumption used to value subprime and other asset backed securities was generally decreased as a result of
increased liquidity in the market.
35
For securities valued with internal models, which have an aggregate fair value of $224.2 million as of December 31, 2009,
a 10% unfavorable change in our assumptions would result in the following decreases in such aggregate fair value (in
thousands):
Outstanding face amount
Fair value
Effect on fair value with 10% unfavorable change in:
Discount rate
Prepayment rate
Default rate
Loss severity
CMBS
$
987,323
ABS
$
432,965
$
128,120
$
96,096
$
$
$
(4,369)
N/A
(36,611)
(22,131)
$
$
$
$
(4,003)
(1,120)
(7,873)
(14,130)
The sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by stressing
a particular economic assumption independent of changes in any other assumption; in practice, changes in one factor may
result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the fair value based on a
10% variation in an assumption generally may not be extrapolated because the relationship of the change in the assumption
to the change in fair value may not be linear.
Our securities must be categorized by the “level” of inputs used in estimating their fair values. Level 1 would be assets
valued based on quoted prices for identical instruments in active markets. We have no level 1 assets. Level 2 would be
assets valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive
markets, or on other “observable” market inputs. Level 3 would be assets valued based significantly on “unobservable”
market inputs. We have further broken level 3 into level 3A, third party indications, and level 3B, internal models. Fair
value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were
forced to sell assets in a short period to meet liquidity needs, the prices we receive could be substantially less than the
recorded fair values.
We generally classify the broker and pricing service quotations we receive as level 3A inputs, except for certain liquid
securities. They are quoted prices in generally inactive and illiquid markets for identical or similar securities. These
quotations are generally received via email and contain disclaimers which state that they are “indicative” and not
“actionable” – meaning that the party giving the quotation is not bound to actually purchase the security at the quoted price.
These quotations are generally based on models prepared by the brokers, and we have little visibility into the inputs they
use. Based on procedures we have performed with respect to prior quotations received from these brokers in comparison to
the outputs generated from our internal pricing models and transactions we have completed with respect to these securities,
as well as on our knowledge and experience of these markets, we have generally determined that these quotes represent a
reasonable estimate of fair value. In addition, management performs its own quarterly analysis of fair value, based on
internal pricing models, to confirm that each of the quotations received represented a reasonable estimate of fair value as
defined under GAAP. For the $1.6 billion of securities valued using quotations, a 100 basis point change in credit spreads
would impact estimated fair value by approximately $48.2 million.
We must also assess whether unrealized losses on securities, if any, reflect a decline in value which is other-than-temporary
and, if so, write the impaired security down to its fair value through earnings. A decline in value is deemed to be other-
than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a
security which was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a
security in an unrealized loss position or it is more likely than not we will be required to sell a security in an unrealized loss
position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we assume the anticipated
recovery period is until the respective security’s expected maturity. Also, for certain securities which represent “beneficial
interests in securitized financial assets,” whenever there is a probable adverse change in the timing or amounts of estimated
cash flows of a security from the cash flows previously projected, an other-than-temporary impairment is considered to
have occurred. These securities are also analyzed for other-than-temporary impairment under the guidelines applicable to
all securities as described herein. We note that primarily all of our securities, except our FNMA/FHLMC securities, fall
within the definition of beneficial interests in securitized financial assets.
36
Temporary declines in value generally result from changes in market factors, such as market interest rates and credit
spreads, or from certain macroeconomic events, including market disruptions and supply changes, which do not directly
impact our ability to collect amounts contractually due. We continually evaluate the credit status of each of our securities
and the collateral supporting our securities. This evaluation includes a review of the credit of the issuer of the security (if
applicable), the credit rating of the security, the key terms of the security (including credit support), debt service coverage
and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting
such loans, including the effect of local, industry and broader economic trends and factors. These factors include loan
default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well
as prepayment rates. These factors are also analyzed in relation to the amount of the unrealized loss and the period elapsed
since it was incurred. The result of this evaluation is considered when determining management’s estimate of cash flows,
particularly with respect to developing the necessary inputs and assumptions. Each security is impacted by different factors
and in different ways; generally the more negative factors which are identified with respect to a given security, the more
likely we are to determine that we do not expect to receive all contractual payments when due with respect to that security.
Significant judgment is required in this analysis.
During the year ended December 31, 2009, we had 242, or $592.5 million carrying amount of, securities that were
downgraded and recorded a net other-than-temporary impairment charge of $346.6 million on these securities in 2009.
However, we do not depend on credit ratings in underwriting our securities, either at acquisition or on an ongoing basis. As
mentioned above, a credit rating downgrade is one factor that we monitor and consider in our analysis regarding other-than-
temporary impairment, but it is not determinative. Our securities generally benefit from the support of one or more
subordinate classes of securities or equity or other forms of credit support. Therefore, credit rating downgrades, even to the
extent they relate to an expectation that a securitization we have invested in, on an overall basis, has credit issues, may not
ultimately impact cash flow estimates for the class of securities in which we are invested.
Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized
loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected
identification of which securities would be sold is also subject to significant judgment, particularly in times of market
illiquidity such as we are currently experiencing.
Revenue Recognition on Securities
Income on these securities is recognized using a level yield methodology based upon a number of cash flow assumptions
that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of principal and interest
receipts (which may be subject to prepayments and defaults). These assumptions are updated on at least a quarterly basis to
reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and
contingencies are difficult to predict and are subject to future events, and economic and market conditions, which may alter
the assumptions. For securities acquired at a discount for credit losses, the net income recognized is based on a “loss
adjusted yield” whereby a gross interest yield is recorded to Interest Income, offset by a provision for probable, incurred
credit losses which is accrued on a periodic basis to Provision for Credit Losses on Loan Pools. The provision is determined
based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.
A rollforward of the provision, if any, is included in Note 5 to our consolidated financial statements in Part II, Item 8,
“Financial Statements and Supplementary Data.”
Valuation of Derivatives
Similarly, our derivative instruments are carried at fair value. Fair value is based on counterparty quotations. Newcastle
reports the fair value of derivative instruments gross of cash paid or received pursuant to credit support agreements and fair
value is reflected on a net counterparty basis when Newcastle believes a legal right of offset exists under an enforceable
netting agreement. To the extent they qualify as cash flow hedges under the current accounting standard, net unrealized
gains or losses are reported as a component of accumulated other comprehensive income; otherwise, they are reported
currently in income. To the extent they qualify as fair value hedges, net unrealized gains or losses on both the derivative
and the related portion of the hedged item are reported currently in income. Fair values of such derivatives are subject to
significant variability based on many of the same factors as the securities discussed above, including counterparty credit
risk. The results of such variability could be a significant increase or decrease in our GAAP equity and/or earnings.
Impairment of Loans
We purchase, directly and indirectly, real estate related, commercial mortgage and residential mortgage loans, including
manufactured housing loans and subprime mortgage loans. We must periodically evaluate each of these loans or loan pools
for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts
due according to the contractual terms of the loan, or, for loans acquired at a discount for credit losses, when it is deemed
probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific
valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment.
Our residential mortgage loans, including manufacture housing loans, are aggregated into pools for evaluation based on like
characteristics, such as loan type and acquisition date. Individual loans are evaluated based on an analysis of the
borrower’s performance, the credit rating of the borrower, debt service coverage and loan to value ratios, the estimated
37
value of the underlying collateral, the key terms of the loan, and the effect of local, industry and broader economic trends
and factors. Pools of loans are also evaluated based on similar criteria, including historical and anticipated trends in defaults
and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate specific
impairment charges on individual loans as well as provisions for estimated unidentified incurred losses on pools of loans.
Significant judgment is required both in determining impairment and in estimating the resulting loss allowance.
Furthermore, we must assess our intent and ability to hold our loan investments on a periodic basis. If we do not have the
intent and ability to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held
for sale” and recorded at the lower of cost or estimated value.
Revenue Recognition on Loans Held for Investment
Income on these loans is recognized similarly to that on our securities and is subject to similar uncertainties and
contingencies, which are also analyzed on at least a quarterly basis. For loans acquired at a discount for credit losses, the
net income recognized is based on a “loss adjusted yield” whereby a gross interest yield is recorded to Interest Income,
offset by a provision for probable, incurred credit losses which is accrued on a periodic basis to Provision for Credit Losses.
The provision is determined based on an evaluation of the loans as described under “Impairment of Loans” above. In the
fourth quarter of 2008, we reclassified all our investments in loans as held for sale as we could no longer express the intent
and ability to hold our loan investment through maturity. A rollforward of the provision is included in Note 5 to our
consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary Data.”
Revenue Recognition on Loans Held for Sale
Real estate related, commercial mortgage and residential mortgage loans that are considered held for sale are carried at the
lower of amortized cost or market value determined on either an individual method basis, or in the aggregate for pools of
similar loans. Interest income is recognized to the extent cash is received whereas a change in the market value of loans, to
the extent that the value is not above the cost basis, is recorded in Valuation Allowance. A rollforward of the provision is
included in Note 5 to our consolidated financial statements in Part II, Item 8, “Financial Statements and Supplementary
Data.”
Recent Accounting Pronouncements
In February 2008, the FASB issued new guidance on accounting for a transfer of a financial asset and a repurchase
financing. It presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same
arrangement (a linked transaction) unless certain criteria are met. If the criteria are not met, the linked transaction would be
recorded as a net investment, likely as a derivative, instead of recording the purchased financial asset on a gross basis along
with a repurchase financing. This guidance applies to reporting periods beginning after November 15, 2008 and is only
applied prospectively to transactions that occur on or after the adoption date. The adoption of this guidance did not have a
material impact on our financial condition, liquidity or results of operations as we have not entered into any such
transactions since January 2009.
In March 2008, the FASB issued new guidance which applies to reporting periods beginning after November 15, 2008 and
requires enhanced disclosures about an entity’s derivative and hedging activities. It does not change the accounting for such
activities. As a result, while the adoption of this guidance has changed our disclosures, it did not have a material impact on
our financial condition, liquidity or results of operations.
In January 2009, the FASB issued new guidance which amends previous guidance to achieve more consistent
determination of whether an other-than-temporary impairment has occurred. In particular, it changed a requirement to
analyze a security’s estimated cash flows from a market participant’s perspective to an analysis from the perspective of the
holder. It is effective for periods ending after December 15, 2008 and is applied prospectively. Due to the prospective
nature of its adoption, the adoption of this guidance did not have a material impact on our financial condition, liquidity or
results of operations. It did not have a material impact on our impairment analyses subsequent to adoption because we
generally analyze cash flows of securities in a manner consistent with market practice.
In April 2009, the FASB issued new guidance which (i) requires disclosures about the fair value of financial instruments on
an interim basis, (ii) changes the guidance for determining, recording and disclosing other-than-temporary impairment, and
(iii) provides additional guidance for estimating fair value when the volume or level of activity for an asset or liability have
significantly decreased. This guidance was effective for Newcastle as of April 1, 2009. It had a significant impact on our
disclosures, but no material impact on our financial condition, liquidity, or results of operations upon adoption. A
reclassification adjustment of $1.3 billion of loss from Accumulated Deficit to Accumulated Other Comprehensive Income
(Loss) was recorded at adoption but had no net effect on equity. Post-adoption impairment determinations, including the
analysis performed at December 31, 2009, are performed using this new guidance and may result in materially different
conclusions than would have been reached under prior guidance.
In June 2009, the FASB issued new guidance which eliminates the concept of qualified special purpose entities (QSPEs),
changes the requirements for reporting a transfer of a portion of financial assets as a sale, clarifies other sale accounting
criteria and changes the initial measurement of a transferor’s interest in transferred financial assets. Furthermore, it requires
38
additional disclosures. This guidance is effective for fiscal years beginning after November 15, 2009. We do not expect
that the adoption of this guidance will have a material impact on our financial position, liquidity or results of operations.
In June 2009, the FASB issued new guidance which changes the definition of a variable interest entity (“VIE”) and changes
the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Furthermore, it
eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to the VIE
consolidation rules. This guidance is effective for fiscal years beginning after November 15, 2009. Generally, the changes
are expected to cause more entities to be defined as VIEs and to require consolidation by the entity that exercises day-to-
day control over a VIE, such as servicers and collateral managers. We expect that the adoption of this standard will cause us
to deconsolidate one of our CDOs and we are currently evaluating the potential impact of this standard on our other
financing structures. The results of deconsolidating any of our CDOs or other non-recourse financing structures would be a
reduction to accumulated deficits, to the extent that we have taken impairments on assets within a given VIE in excess of
our investment in such VIE, and reductions of the assets and liabilities of such VIE. These reductions could be material.
We do not expect any other immediate effects from the adoption of this guidance, but our ongoing consolidation analyses
will be altered. To the extent the conclusions of any future analyses are changed as a result of this guidance, the impact
could be material.
Results of Operations
The following table summarizes the changes in our results of operations from year-to-year (dollars in thousands):
Year-to-Year
Increase (Decrease)
Year-to-Year
Percent Change
Explanation
2009/2008
2008/2007
2009/2008
2008/2007
2009/2008
2008/2007
Interest income
$
(107,001)
$
(211,668)
(22.8%)
(31.1%)
Interest expense
Provision for credit losses on loan pools
Valuation allowance on loans
Other-than-temporary impairment on securities, net
Gain (loss) on settlement of investments, net
Gain (loss) on extinguishment of debt
Other income (loss), net
Equity in earnings of unconsolidated subsidiaries
Loan and security servicing expense
General and administrative expense
Management fee to affiliate
Incentive compensation to affiliate
Depreciation and amortization
Income (loss) from continuing operations
(88,893)
(8,457)
(970,670)
(1,464,163)
70,106
201,455
76,384
(7,737)
(1,615)
1,312
(420)
-
1
2,766,112
$
(169,629)
(1,937)
978,352
1,795,094
(72,662)
28,856
(62,885)
2,767
(3,070)
1,437
743
(6,209)
(2)
(2,910,371)
$
(28.9%)
(100.0%)
N.M.
N.M.
119.5%
N.M.
N.M.
(94.9%)
(24.3%)
18.0%
(2.3%)
0.0%
0.3%
93.0%
(35.6%)
(18.6%)
N.M.
N.M.
N.M.
N.M.
N.M.
51.3%
(31.6%)
24.5%
4.2%
(100.0%)
(0.7%)
418.1%
(1)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(1)
(9)
(10)
(10)
N/A
(1)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(1)
(9)
(10)
(10)
N/A
N.M. – Not meaningful
(1) Changes in interest income and expense are primarily related to our acquisition and disposition during these periods of
interest bearing assets and related financings, as follows:
Year-to-Year Increase (Decrease)
Interest Income
2009/2008
Interest Expense
2009/2008
$
$
Disposition of securities and loans
Prepayment penalty income
Repayment of debt obligations and related dispositions
Paydowns
Amortization of deferred hedge loss
Other (see below)
Disposition of securities and loans
New debt obligations and related asset acquisitions
Repayment of debt obligations and related dispositions
Paydowns
Other (see below)
39
(33,491)
8,158
(4,004)
(22,302)
-
(55,362)
(107,001)
(77,867)
42,737
(84,035)
(29,601)
(62,902)
(211,668)
$
$
Year-to-Year Increase (Decrease)
Interest Income
2008/2007
Interest Expense
2008/2007
$
$
$
$
(20,680)
-
(9,877)
(12,774)
11,632
(57,194)
(88,893)
(62,109)
28,647
(65,684)
(17,661)
(52,822)
(169,629)
Changes in Other are primarily due to changes in interest rates, partially offset in 2009 by increased interest income as
a result of the accretion of discounts on impaired securities.
Changes in loan and security servicing expense are primarily due to dispositions and paydowns.
(2) The change in 2009 is primarily the result of the classification of loans as held for sale in the fourth quarter of 2008 as
we could no longer express the intent and ability to hold our loan investments through maturity. As a result, changes in
fair values of the residential loan pools for the year ended December 31, 2009 were recorded to Valuation Allowance
on Loans. The change in 2008 is primarily due to a decreased provision for our pool of manufactured housing loans as
a result of paydowns.
(3) The changes are a result of the classification of loans as held for sale in the fourth quarter of 2008 as we could no
longer express the intent and ability to hold our loan investments through maturity.
(4) The changes are due to the impairment charges recorded as a result of the continued credit market turmoil, which led
us to record write downs to a significant portion of our securities portfolio particularly in the fourth quarter of 2008 as
we were not able to express the intent and ability to hold our investments through maturity or recovery.
(5) The changes are a result of the net gain or loss on the sale of securities, loans and termination of derivatives during the
respective years. The increase from 2008 to 2009 is predominantly the result of the gains recorded on paydown at par
of securities previously written down, partially offset by the loss on sales of certain securities and loans. The increase
in the loss on sale of investments in 2008 is predominantly the result of the sales of loans and securities in an
unrealized loss position in the fourth quarter of 2008 due to the credit and liquidity crisis.
(6) The changes are a result of the increased gain on the repurchase of our own debt.
(7) The changes are primarily the net result of the change in fair value of total rate of return swaps (which were terminated
in 2008) and change in fair value of interest rate swaps not designated as accounting hedges, which we mark to market
through the statements of operations.
(8) The changes are primarily due to gain recorded for the sale of our interests in the operating real estate joint venture in
2008.
(9) The changes are primarily due to increases in insurance expense, legal and professional fees.
(10) Management fees have remained relatively stable as we did not raise capital through common or preferred stock
offerings during these periods. As a result of impairment charges, we will not incur incentive compensation to our
manager for an indefinite period of time.
Liquidity and Capital Resources
Overview
Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay
borrowings, fund and maintain investments, and other general business needs. Additionally, to maintain our status as a
REIT under the Code, we must distribute annually at least 90% of our REIT taxable income. We note that we believe we
have already met this requirement for 2009 and that up to 90% of this requirement may be met in future years through stock
dividends rather than cash, subject to limitations based on the value of our stock. Our primary sources of funds for liquidity
consist of net cash provided by operating activities, sales or repayments of investments, potential refinancing of existing
debt, and the issuance of equity securities, when feasible. Our debt obligations are generally secured directly by our
investment assets except for the junior subordinated notes payable.
Sources of Liquidity and Uses of Capital
As of the date of this filing, we currently have sufficient cash on hand to satisfy all of our non-agency recourse liabilities
(excluding our junior subordinated notes payable, which are long-term obligations). With respect to the next twelve
months, we expect that our cash on hand combined with our cash flow provided by operations will be sufficient to satisfy
our anticipated liquidity needs with respect to our current investment portfolio, including related financings, hedges,
potential margin calls and operating expenses. While it is inherently more difficult to forecast beyond the next twelve
months, we currently expect to meet our long-term liquidity requirements, specifically the repayment of our debt
obligations, through our cash on hand and, if needed, additional borrowings, proceeds received from repurchase agreements
and similar financings, and the liquidation or refinancing of our assets.
These short-term and long-term expectations are forward-looking and subject to a number of uncertainties and assumptions,
which are described below under “–Factors That Could Impact Our Liquidity” as well as Part I, Item 1A, “Risk Factors.” If
our assumptions about our liquidity prove to be incorrect, we could be subject to a shortfall in liquidity in the future, and
this short-fall may occur rapidly and with little or no notice, which would limit our ability to address the shortfall on a
timely basis.
Cash flow provided by operations constitutes a critical component of our liquidity. Essentially, our cash flow provided by
operations is equal to (i) the net cash flow from our CDOs that have not failed their over collateralization or interest
40
coverage tests, plus (ii) the net cash flow from our non-CDO investments that are not subject to mandatory debt repayment,
including principal and sales proceeds, less (iii) operating expenses (primarily management fees, professional fees and
insurance), and less (iv) interest on the junior subordinated notes payable.
Our cash flow provided by operations differs from our net income (loss) due to these primary factors: (i) accretion of
discount or premium on our real estate securities and loans (including the accrual of interest and fees payable at maturity),
discount on our debt obligations, deferred financing costs and interest rate cap premiums, and deferred hedge gains and
losses, (ii) gains and losses from sales of assets financed with CDOs, (iii) the provision for credit losses and valuation
allowance recorded in connection with our loan assets, as well as other-than-temporary impairment on our securities, (iv)
unrealized gains or losses on our non-hedge derivatives, (v) the non-cash charges associated with our early extinguishment
of debt, and (vi) net income (loss) generated within CDOs that have failed their over collateralization or interest coverage
tests, and one of the manufactured housing loan portfolios whose financing became callable in January 2009, and therefore
do not remit cash to us. Proceeds from the sale of assets which serve as collateral for our CDO financings, including gains
thereon, are required to be retained in the CDO structure until the related bonds are retired and are therefore not available to
fund current cash needs outside of these structures.
Update on Liquidity, Capital Resources and Capital Obligations
Certain details regarding our liquidity, current financings and capital obligations as of February 17, 2010 are set forth
below:
• Cash – We had unrestricted cash of $58.8 million. In addition, we had $201.5 million of restricted cash held for
reinvestment in our CDOs;
• Margin Exposure – We have no financings subject to margin calls, other than one repurchase agreement with a
face amount of $39.6 million which finances our FNMA/FHLMC investments and four interest rate swap
agreements with an aggregate notional amount of $67.4 million;
• Recourse Financings – Substantially all of our assets, other than our FNMA/FHLMC investments, are currently
financed with term debt subject to amortization payments through September 30, 2010. The following table
compares the face amount of our recourse financings, excluding the junior subordinated notes:
February 17, 2010
December 31, 2009
Real Estate Securities, Loans and Properties
Manufactured Housing Loans
Non-FNMA/FHLMC recourse financings
FNMA/FHLMC Securities
Total recourse financings
$
$
21,276
8,105
29,381
39,556
68,937
31,672
10,606
42,278
39,637
81,915
$
$
The following table summarizes the scheduled repayments of our non-FNMA/FHLMC recourse financings as of February
17, 2010:
February 18, 2010 to March 31, 2010
$
9,000
2nd Quarter 2010
3rd Quarter 2010
16,000
4,381
Total non-FNMA/FHLMC recourse financings
$
29,381
It is important for readers to understand that our liquidity, available capital resources and capital obligations could change
rapidly due to a variety of factors, many of which are beyond our control. Set forth below is a discussion of some of the
factors that could impact our liquidity, available capital resources and capital obligations.
Factors That Could Impact Our Liquidity, Capital Resources and Capital Obligations
We refer readers to our discussions in other sections of this report for the following information:
• For a further discussion of recent trends and events affecting our liquidity, see “– Market Considerations” above;
• As described below, under “– Interest Rate, Credit and Spread Risk,” we are subject to margin calls in connection
with our derivatives related to the non-recourse financing structures;
• Our match funded investments are financed long term, and their credit status is continuously monitored, which is
described under "Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Exposure'' below.
Our remaining investments, generally financed with short term debt or short term repurchase agreements, are also
subject to refinancing risk upon the maturity of the related debt. See “Debt Obligations” below; and
• For a further discussion of a number of risks that could affect our liquidity, access to capital resources and our
capital obligations, see Part I, Item 1A, “Risk Factors” above.
41
In addition to the information referenced above, the following factors could also affect our liquidity, access to capital
resources and our capital obligations. As such, if their outcomes do not fall within our expectations, changes in these factors
could negatively affect our liquidity.
•
• Access to Financing from Counterparties – Decisions by investors, counterparties and lenders to enter into
transactions with us will depend upon a number of factors, such as our historical and projected financial
performance, compliance with the terms of our current credit and derivative arrangements, industry and market
trends, the availability of capital and our investors’, counterparties’ and lenders’ policies and rates applicable
thereto, and the relative attractiveness of alternative investment or lending opportunities. As we discuss in more
detail under “–Market Considerations” above, the continued challenging credit and liquidity conditions have
limited the array of capital resources available to us and made the terms of capital resources we are able to obtain
generally less favorable to us relative to the terms we were able to obtain prior to the onset of challenging
conditions. For example, we are currently contractually restricted from entering into new debt financings subject to
margin calls other than to finance up to a specified amount of FNMA/FHLMC securities. Our core business
strategy is dependent upon our ability to finance our real estate securities, loans and other real estate related assets
with match funded debt at rates that provide a positive net spread. Currently, spreads for such liabilities have
widened and demand for such liabilities has become extremely limited, therefore restricting our ability to execute
future financings.
Impact of Rating Downgrades on CDO Cash Flows – Ratings downgrades of assets in our CDOs can negatively
impact compliance with the CDOs’ over collateralization tests. Generally, the over collateralization test measures
the principal balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the
CDO. However, based on ratings downgrades, the principal balance of an asset or of a specified percentage of
assets in a CDO may be deemed to be reduced below their current balance to levels set forth in the related CDO
documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce
the assumed principal balance of the assets used in the over collateralization test relative to the corresponding
liabilities in the test, thereby reducing the over collateralization percentage. In addition, actual defaults of assets
would also negatively impact compliance with the over collateralization tests. Failure to satisfy an over
collateralization test could result in the redirection of cashflows, or, in certain cases, in the potential removal of
Newcastle as collateral manager of the affected CDO. See “Debt Obligations” below for a summary of assets on
negative watch for possible downgrade in our CDOs.
Impact of Expected Repayment or Forecasted Sale on Cash Flows – The timing of and proceeds from the
repayment or sale of certain investments may be different than expected or may not occur as expected. Proceeds
from sales of assets in the current illiquid market environment are unpredictable and may vary materially from
their estimated fair value and their carrying value.
•
Investment Portfolio
Our investment portfolio as of December 31, 2009 is detailed in Part I, Item 1, “Business – Our Investment Strategy.”
Debt Obligations
Our debt obligations, as summarized in Note 8 to Part II, Item 8, “Financial Statements and Supplementary Data,” existing
at December 31, 2009 (gross of $11.5 million of discounts) had contractual maturities as follows (unaudited) (in
thousands):
2010
2011
2012
2013
2014
Thereafter
Total
Nonrecourse
107,003
$
187,191
-
-
-
4,473,513
4,767,707
$
Recourse
$
81,515
-
-
-
-
102,500
184,015
$
Total
188,518
187,191
-
-
-
4,576,013
4,951,722
$
$
Certain of the debt obligations included above are obligations of our consolidated subsidiaries which own the related
collateral. In some cases, including the CDO and Other Bonds Payable, such collateral is not available to other creditors of
ours.
Our non-CDO obligations contain various customary loan covenants. We were in compliance with all of the covenants in
our non-CDO financings as of December 31, 2009.
Our Other Bonds Payable are collateralized by two portfolios of manufactured housing loans. In January 2009, the debt for
one of the portfolios of manufactured housing loans ($107.0 million outstanding at December 31, 2009) became callable at
the option of the lender. The principal and interest payments from the underlying loans, net of expenses and payments
related to interest rate swap contracts, are used to repay the outstanding debt on a monthly basis.
42
In March 2006, we acquired a portfolio of subprime mortgage loans (“Subprime Portfolio I”) for $1.50 billion. In April
2006, Newcastle Mortgage Securities Trust 2006-1 (“Securitization Trust 2006”) closed on a securitization of Subprime
Portfolio I. We do not consolidate Securitization Trust 2006. We sold Subprime Portfolio I to Securitization Trust 2006,
which issued $1.45 billion of notes with a stated maturity of March 2036. We, as holder of the equity of Securitization
Trust 2006, have the option to redeem the notes once the aggregate principal balance of Subprime Portfolio I is equal to or
less than 20% of such balance at the date of the transfer. The transaction between us and Securitization Trust 2006 qualified
as a sale for accounting purposes. However, 20% of the loans which are subject to a call option by us were not treated as
being sold. Following the securitization, we held the following interests in Subprime Portfolio I: (i) the equity of
Securitization Trust 2006, (ii) the retained notes, and (iii) subprime mortgage loans subject to call option and related
financing in the amount of 100% of such loans (we note that this interest is non-economic if we do not exercise the option,
meaning that it has no impact on us).
In March 2007, we entered into an agreement to acquire a portfolio of subprime mortgage loans (“Subprime Portfolio II”)
with up to $1.7 billion of unpaid principal balance. In July 2007, Newcastle Mortgage Securities Trust 2007-1
(“Securitization Trust 2007”) closed on a securitization of Subprime Portfolio II. As a result of the repurchase of delinquent
loans by the seller, as well as borrower repayments, the unpaid principal balance of the portfolio upon securitization was
$1.1 billion. We do not consolidate Securitization Trust 2007. We sold Subprime Portfolio II to Securitization Trust 2007,
which issued $1.0 billion of notes with a stated maturity of April 2037. We, as holder of the equity of Securitization Trust
2007, have the option to redeem the notes once the aggregate principal balance of Subprime Portfolio II is equal to or less
than 10% of such balance at the date of the transfer. The transaction between us and Securitization Trust 2007 qualified as a
sale for accounting purposes. However, 10% of the loans which are subject to a call option by us were not treated as being
sold. Following the securitization, we held the following interests in Subprime Portfolio II: (i) the equity of Securitization
Trust 2007, (ii) the retained notes, and (iii) subprime mortgage loans subject to call option and related financing in the
amount of 100% of such loans (we note that this interest is non-economic if we do not exercise the option, meaning that it
has no impact on us).
We have no obligation to repurchase any loans from either of our subprime securitizations. Therefore, it is expected that our
exposure to loss is limited to the carrying amount of our retained interests in the securitization entities, as described above.
A subsidiary of Newcastle gave limited representations and warranties with respect to Subprime Portfolio II; however, it
has no assets and does not have recourse to the assets of Newcastle.
During 2008, we repurchased $24.9 million face amount of CDO bonds for $7.9 million and recorded a gain of $16.8
million. During 2009, we repurchased $246.7 million face amount of CDO bonds for $29.9 million and recorded a gain of
$215.3 million.
During 2008, we had significant asset sales and associated debt repayments and recorded significant impairment, as
reflected in Part II, Item 8, “Financial Statements and Supplementary Data.”
On April 30, 2009, we entered into an exchange agreement with several collateralized debt obligations managed by a third
party pursuant to which we agreed to exchange newly issued junior subordinated notes due in 2035 with an initial aggregate
principal amount of $101.7 million (the "Notes") for $100 million in aggregate liquidation amount of trust preferred
securities that were previously issued by a subsidiary of us (the “TRUPs”) and were owned by the third party. The Notes
accrue interest at a rate of 1.0% per year for a maximum of six quarters, beginning on February 1, 2009 and the aggregate
principal amount of the Notes will increase to $104.9 million by July 31, 2010. Subsequent to that period, the rate reverts to
that which we were required to pay on the TRUPs (7.574% through April 2016 and at a floating rate of 3-month LIBOR
plus 2.25% thereafter). In conjunction with the exchange, the TRUPs were cancelled and we pledged 100% of our equity
interests in NIC TP LLC, a special purpose subsidiary that holds our participation in a loan and related deposit account,
which were valued at $4.1 million on December 31, 2009, as collateral. The pledged collateral will be released at the end of
the interest rate modification period. This exchange is considered a troubled debt restructuring under GAAP which requires
us to account for the effect of the interest modification prospectively and to record expenses related to the modification
immediately through earnings.
On January 29, 2010, Newcastle Investment Corp. (together with its wholly-owned taxable REIT subsidiary, NIC TRS
LLC, the “Company”), entered into an Exchange Agreement, dated as of January 29, 2010 (the “Exchange Agreement”),
with Taberna Capital Management, LLC and certain of its affiliates (collectively, “Taberna”), pursuant to which the
Company and Taberna agreed to exchange (the “Exchange”) approximately $51.9 million aggregate principal amount of
junior subordinated notes due 2035 for approximately $37.6 million face amount of previously issued CDO securities and
approximately $9.7 million of cash held by the Company. In other words, as of February 11, 2010, $51.9 million face
amount of the company’s debt, in the form of junior subordinated notes payable, was repurchased and effectively retired in
exchange for (i) the payment of $9.7 million of cash, and (ii) the reissuance of $37.6 million face amount of CDO bonds
payable (which had previously been repurchased by the Company). In connection with the Exchange, the Company paid or
reimbursed certain expenses incurred by Taberna, various indenture trustees and their respective advisors in accordance
with the terms of the Exchange Agreement. The Company is currently evaluating the impact of this exchange on our
financial results, which will be recorded in the first quarter of 2010.
43
The following table summarizes our CDO financings as of December 31, 2009 (dollars in thousands). The amounts reflect data at the CDO level which is unconsolidated and
thus is different from the GAAP balance sheet due to intercompany amounts eliminated in consolidation.
Balance Sheet:
CDO IV
CDO V
CDO VI
CDO VII (12)
CDO VIII
CDO IX
CDO X
Total /
Weighted
Average
Asset Face Amount
$
419,419
$
507,465
$
483,518
$
493,984
$
919,166
$
840,028
$
1,417,309
$
5,080,889
Asset Amortized Cost Basis
Debt Carrying Value
Invested Equity (1)
$
355,969
373,397
$
-
$
391,182
445,498
$
-
$
261,483
436,111
$
-
$
189,180
450,986
$
-
$
512,406
728,383
$
-
$
431,804
547,777
$
-
$
1,031,875
1,223,285
$
-
$
3,173,899
4,205,437
$
-
Quarterly Net cash receipts (2)
$
128
$
165
$
142
$
139
$
3,720
$
5,134
$
3,451
$ 12,879
$
88,623
$
135,690
$
184,413
$
229,450
$
130,121
$
41,750
$
239,965
$ 1,050,012
60.0% BB
22.6% BBB-
12.9% BBB-
0.0% --
2.2% C
65.8% BB+
15.6% BB+
17.5% B+
1.1% AAA
0.0% --
65.4% BB
14.6% BBB-
15.6% B
0.0% --
4.2% CC
2.3% BB+
0.0% --
0.0% --
0.0% --
0.0% --
0.0% --
67.5% B
13.6% BBB
16.7% CCC+
0.0% --
2.2% C
0.0% --
0.0% --
21.2% BB-
1.6% D
7.2% BB-
0.0% --
11.1% CCC
11.7% BB
0.0% --
0.1% --
0.0% --
16.7% CCC
63.2% BBB-
13.5% BB-
13.8% BB+
0.0% --
2.3% CC
37.2% CCC+
9.8% B
66.7% B-
1.7% BB-
0.0% --
3.0% C
47.7%
10.2%
11.1%
0.1%
6.2%
17.9%
2.9%
0.0% --
100.0% BB+
0.0% --
100.0% BB
0.2% --
100.0% BB-
0.0% --
100.0% B+
11.9% --
100.0% B-
3.1% --
100.0% B-
4.2% --
100.0% BB+
3.9%
100.0%
Mar-07
Nov-11
Dec-09
Nov-16
44
3.7
3.8
9.8%
8.5%
249.8%
287.5%
Jul-07
May-12
Jun-10
May-17
57
2.3
4.8
10.5%
11.0%
359.0%
354.8%
Dec-07
Jul-12
Aug-10
Jul-17
34
3.6
5.2
2.8%
5.1%
163.4%
181.5%
43
3.4
4.4
Aug-05
Apr-10
May-08
Apr-15
39
3.2
4.1
(21.8)%
(24.3)%
279.0%
45.6%
Jan-06
Dec-10
Jan-09
Dec-15
47
4.0
5.7
(49.2)%
(51.9)%
179.7%
69.3%
44
Collateral on negative
watch (3)
Collateral Composition (4):
CMBS
REIT Debt
ABS
FNMA/FHLMC
Bank Loans
Mezzanine Loans / B-Notes /
Whole Loans
CDO
Restricted Cash for
Reinvestment
Total
CDO Overview:
Effective Date
Reinvestment Period Ends (5)
Optional Call Date (6)
Auction Call Date (7)
Avg Debt Spread (bps) (8)
Asset Weighted Average Life
Debt Weighted Average Life
Sep-04
Mar-09
Jun-07
Mar-14
53
3.4
2.8
Feb-05
Sep-09
Dec-07
Sep-14
45
3.5
3.2
(3.8)%
--
CDO Cash Flow Triggers (9):
Over Collateralization Excess (Deficiency) (10)
As of December 2009
remittance (11)
As of January 2010
remittance (11)
(6.8)%
--
Interest Coverage Excess (Deficiency) (10)
As of December 2009
remittance
As of January 2010
remittance
122.1%
215.0%
--
--
See footnotes on next page
(1) Given the non-recourse nature of our CDO liabilities, invested equity cannot be less than zero. As of period end, our GAAP equity in our CDOs was
$1.0 billion in the aggregate lower than our invested equity due to impairment recorded in excess of our maximum possible economic loss.
(2) Represents net cash received from each CDO based on all of our interests in such CDO (including senior management fees) for the three months
ended December 31, 2009. Cash receipts for this period included $0.9 million of non-recurring prepayment fees and may not be indicative of cash
receipts for subsequent periods. See “Cautionary Note Regarding Forward Looking Statements” for risks and uncertainties that could cause our
receipts for subsequent periods to differ materially from these amounts.
(3) Represents the face amount of assets on negative watch for possible downgrade by at least one rating agency (Moody’s, S&P, or Fitch) as of the
determination date of December 17, 2009 for CDO IV and V, as these deals only report actual over collateralization excess percentages on a
quarterly basis, and as of the latest determination date of January 20, 2010 for all other CDOs. The amounts include CDO bonds of $54.6 million
issued by Newcastle, which are eliminated in consolidation and not reflected in our investment portfolio segments.
(4) Collateral composition is calculated as a percentage of the face amount of collateral and includes CDO bonds of $146.6 million and other bonds of
$63.7 million issued by Newcastle, which are eliminated on consolidation. Also reflected are weighted average credit ratings, which were
determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a
“negative watch”) at any time.
(5) Our CDO financings typically have a 5 year reinvestment period. Generally, after such period ends, principal payments on the collateral are used to
paydown the most senior debt outstanding. Prior to the end of the reinvestment period, principal payments received on the collateral are reinvested.
(6) At the option call date, Newcastle, as the equity holder, has the right to payoff the CDO bonds at their related redemption price.
(7) At the auction call date, there is a mandatory auction of the assets. If the prices are sufficient to pay off the outstanding CDO bonds, the assets will be
sold and the CDO bonds will be redeemed.
(8) Debt spread represents the spread above the benchmark interest rate (LIBOR or U.S. Treasuries) that Newcastle pays on its debt.
(9) Each of our CDO financings contains tests that measure the amount of over collateralization and excess interest in the transaction. Failure to satisfy
these tests would cause the principal and/or interest cashflow that would otherwise be distributed to more junior classes of securities (including those
held by Newcastle) to be redirected to pay down the most senior class of securities outstanding until the tests are satisfied. As a result, our cash flow
and liquidity are negatively impacted upon such a failure, and the impact could be material. Each CDO contains tests at various over collateralization
and interest coverage percentage levels. The trigger percentages identified above represent the first threshold at which cashflows would be redirected
as described in this footnote. The data presented is as of the most recent remittance date on or before December 31, 2009 or January 31, 2010, as
applicable, and may change or have changed subsequent to that date. CDOs IV and V only report on a quarterly basis and, therefore, no updated
January 31, 2010 information is available. In addition, our CDOs may also contain specific over collateralization tests that, if failed, can result in the
occurrence of an event of default or our being removed as collateral manager of the CDO. Failure of the over collateralization tests can also cause a
“phantom income” issue if cash that constitutes income is diverted to pay down debt instead of distributed to us. As of February 17, 2010, CDOs IV,
V, VI and VII were not in compliance with their applicable over collateralization tests and, consequently, we were not receiving cash flows from
these CDOs currently (other than senior management fees). Based upon our current calculations, we expect these portfolios to remain out of
compliance for the foreseeable future. Moreover, given current market conditions, it is possible that all of our CDOs could be out of compliance
with their over collateralization tests as of one or more measurement dates within the next twelve months. Our ability to rebalance will depend upon
the availability of suitable securities, market prices, whether the reinvestment period of the applicable CDO has ended, and other factors that are
beyond our control; such rebalancing efforts may be extremely difficult given current market conditions and we cannot assure you that we will be
successful in our rebalancing efforts. If the liabilities of our CDOs are downgraded by Moody’s to certain predetermined levels, our discretion to
rebalance the applicable CDO portfolios may be negatively impacted. Moreover, if we bring these coverage tests into compliance, we cannot assure
you that they will not fall out of compliance in the future or that we will be able to correct any noncompliance. For a more detailed discussion of the
impact of CDO financings on our cash flows, see Part I, Item 1A, “Risk Factors – The use of CDO financings with coverage tests may have a
negative impact on our operating results and cash flows.”
(10) Represents excess or deficiency under the applicable over collateralization or interest coverage tests to the first threshold at which cash flow would
be redirected. We generally do not receive material cash flow from the CDO until a deficiency is corrected. Ratings downgrades of assets in our
CDOs can negatively impact compliance with the over collateralization tests. Generally, the over collateralization test measures the principal
balance of the specified pool of assets in a CDO against the corresponding liabilities issued by the CDO. However, based on ratings downgrades, the
principal balance of an asset or of a specified percentage of assets in a CDO may be deemed reduced below their current balance to levels set forth in
the related CDO documents for purposes of calculating the over collateralization test. As a result, ratings downgrades can reduce the principal
balance of the assets used in the over collateralization test relative to the corresponding liabilities in the test, thereby reducing the over
collateralization percentage. In addition, actual defaults of an asset would also negatively impact compliance with the over collateralization tests.
Failure to satisfy an over collateralization test could result in the redirection of cashflows as described in footnote 9 above or, in certain
circumstances, in our removal as manager of the applicable portfolio.
(11) Results do not include the expected default of a $59.1 million of our Stuyvesant town Mezzanine loan held in CDO IX, which would eliminate a
substantial amount of the excess overcollateralization cushion in CDO IX.
(12) As a result of CDO VII failing additional over collateralization tests in the fourth quarter of 2009, an event of default has occurred and we may be
removed as the collateral manager under the documentation governing CDO VII. So long as the event of default continues, we will not be permitted
to purchase or sell any collateral in CDO VII. If we are removed as the collateral manager of CDO VII, we would no longer receive the senior
management fees from such CDO. As of February 17, 2010, we have not been removed as collateral manager.
Stockholders’ Equity
Common Stock
The following table presents information on shares of our common stock issued since our formation.
Year
Shares
Issued
Range of Issue
Prices per Share (1)
Net Proceeds
(millions)
Options Granted
to Manager
Formation - 2004
39,859,481
2005
4,053,928
2006
1,800,408
2007
7,065,362
2008
9,871
123,463
2009
December 31, 2009 52,912,513
$29.60
$29.42
$27.75-$31.30
N/A
N/A
2,325,727
330,000
170,000
698,000
0
0
$108.2
$51.2
$201.3
$0.1
$0.1
45
(1) Excludes prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors.
Through December 31, 2009, our manager had assigned, for no value, options to purchase approximately 1.2 million shares
of our common stock to certain of our manager’s employees, of which approximately 0.4 million had been exercised. In
addition, our manager had exercised 0.6 million of its options.
As of December 31, 2009, our outstanding options had a weighted average strike price of $26.64 and were summarized as
follows:
Held by our manager
Issued to our manager and subsequently assigned
to certain of our manager's employees
Held by directors and former directors
Total
1,686,447
798,162
14,000
2,498,609
Preferred Stock
In March 2003, we issued 2.5 million shares ($62.5 million face amount), of 9.75% Series B Cumulative Redeemable
Preferred Stock (the “Series B Preferred”). In October 2005, we issued 1.6 million shares ($40.0 million face amount) of
8.05% Series C Cumulative Redeemable Preferred Stock (the “Series C Preferred”). In March 2007, we issued 2.0 million
shares ($50.0 million face amount) of 8.375% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred).
The Series B Preferred, Series C Preferred and Series D Preferred have a $25 liquidation preference, no maturity date and
no mandatory redemption. We have the option to redeem the Series B Preferred that began in March 2008, the Series C
Preferred beginning in October 2010 and the Series D Preferred beginning in March 2012. If the Series C Preferred and
Series D Preferred cease to be listed on the NYSE or the AMEX, or quoted on the NASDAQ, and we are not subject to the
reporting requirements of the Exchange Act, we have the option to redeem the Series C Preferred or Series D Preferred, as
applicable, at their face amount and, during such time any shares of Series C Preferred or Series D Preferred are
outstanding, the dividend will increase to 9.05% or 9.375% per annum, respectively.
Beginning in the fourth fiscal quarter of 2008, our board of directors elected not to declare any of the specified dividends on
our three series of preferred stock and those dividends are now five quarters in arrears. Until we pay all accrued dividends
on our preferred shares, we cannot pay any dividends on our common shares, pay any consideration to repurchase or
otherwise acquire shares of our common stock or redeem any shares of any series of our preferred stock without redeeming
all of our outstanding preferred shares in accordance with the governing documentation. Moreover, if we do not pay
dividends on any series of preferred stock for six or more periods, then holders of each affected series obtain the right to
call a special meeting and elect two members to our board of directors. Consequently, if we do not make a dividend
payment on our preferred stocks by April 30, 2010, it could restrict the actions that we may take with respect to our
common stock and preferred stock and could affect the composition of our board and, thus, the management of our
business. No assurance can be given that we will pay any dividends on any series of our preferred stock in the future.
46
Accumulated Other Comprehensive Income (Loss)
During the year ended December 31, 2009, our accumulated other comprehensive income changed due to the following
factors (in thousands):
Gains / Losses on
Cash Flow Hedges
Gains / Losses on
Securities
Total Accumulated Other
Comprehensive Income
(Loss)
Accumulated other comprehensive income (loss), December 31, 2008
$ (314,323) $ 6,750
$ (307,573)
Net unrealized gain (loss) on securities
-
306,626
306,626
Reclassification of net realized (gain) loss on securities into earnings
- 522,625 522,625
Net unrealized gain (loss) on derivatives designated as cash flow hedges
into earnings
Reclassification of net realized (gain) loss on derivatives designated as
cash flow hedges into earnings
Reclassification upon adoption of new impairment guidance
(discussed above)
123,926
-
123,926
9,502
-
9,502
-
(1,288,924) (1,288,924)
Accumulated other comprehensive income (loss), December 31, 2009
$
(180,895)
$
(452,923)
$
(633,818)
Our GAAP equity changes as our real estate securities portfolio and derivatives are marked to market each quarter, among
other factors. The primary causes of mark to market changes are changes in interest rates and credit spreads. During the
year, a recharacterization of unrealized non-credit losses upon the adoption of newly issued impairment guidance and a net
tightening of credit spreads have caused a net increase in unrealized losses recorded in accumulated other comprehensive
income on our real estate securities. Net unrealized losses on derivatives designated as cash flow hedges decreased for the
year primarily as a result of increases in long-term interest rates.
See “– Market Considerations” above for a further discussion of recent trends and events affecting our unrealized gains and
losses as well as our liquidity.
Common Dividends Paid
Cash Flow
Operating Activities
Declared for the Period Ended
March 31, 2008
June 30, 2008
September 30, 2008
December 31, 2008
December 31, 2009 (Year)
Paid
April 2008
July 2008
October 2008
N/A
N/A
Amount Per Share
$0.25
$0.25
$0.25
$0.00
$0.00
Net cash flow provided by (used in) operating activities decreased from $118.2 million for the year ended December 31,
2008 to $84.2 million for the year ended December 31, 2009. It increased from ($6.5) million for the year ended December
31, 2007 to $118.2 million for the year ended December 31, 2008. These changes primarily resulted from the acquisition
and settlement of our investments as described above, most notably due to our acquisition and securitization of a pool of
subprime residential mortgage loans in 2007, which was classified as an operating activity, although the net cash out flows
relating to the securitization represent an investment in the securitization vehicle. The negative operating cash flow in 2007
is primarily the result of the investment in the subprime securitization vehicle.
Operating Activities – Comparative 2009 vs. 2008
Cash interest received for investments in securities and loans decreased approximately $136.5 million as a result of a lower
average balance of interest bearing securities and loans of $5.3 billion in 2009 compared to $6.5 billion in 2008 and a
decrease in the weighted average coupon to 4.95% in 2009 from 5.24% in 2008. The lower asset balance is primarily a
result of the paydowns and a higher volume of asset sales in 2008 and 2009. Moreover, cash interest received on cash
deposits decreased by $4.3 million as a result of a lower money market interest rate.
Cash interest paid decreased approximately $110.6 million due to a lower average debt balance of $4.8 billion in 2009
compared to $5.6 billion in 2008 and a decrease in the weighted average coupon to 0.94% in 2009 from 3.42% in 2008,
partially offset by a net increase in interest payments on our interest rate swaps which experienced a decrease in their
average notional balance to $2.4 billion in 2009 from $3.0 billion in 2008 and an increase in their effective pay rate to
5.06% in 2009 from 4.84% in 2008.
47
Incentive compensation payments decreased by $6.2 million for the twelve months ended December 31, 2009, as a result of
the payment of the 2007 incentive compensation in September 2008. We did not make a similar payment in 2009 as we
have not incurred any incentive compensation.
Investing Activities
Investing activities provided (used) $206.4 million, $1.7 billion and $34.0 million during the years ended December 31,
2009, 2008 and 2007, respectively. Investing activities consisted primarily of the investments made in real estate securities
and loans outside of our CDO financing structures, net of proceeds from the sale or settlement of investments.
Financing Activities
Financing activities provided (used) ($272.0) million, ($1.8) billion and $23.1 million during the years ended December 31,
2009, 2008 and 2007, respectively. The equity issuances, borrowings and debt issuances described above served as the
primary sources of cash flow from financing activities. Offsetting uses included the payment of related deferred financing
costs, payments related to hedging instruments, the payment of dividends, and the repayment of debt as described above.
See the consolidated statements of cash flows in our consolidated financial statements included in “Financial Statements
and Supplementary Data” for a reconciliation of our cash position for the periods described herein.
Interest Rate, Credit and Spread Risk
We are subject to interest rate, credit and spread risk with respect to our investments. These risks are further described in
Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
Off-Balance Sheet Arrangements
As of December 31, 2009, we had two material off-balance sheet arrangements. We believe that these off-balance sheet
structures presented the most efficient and least expensive form of financing for these assets at the time they were entered,
and represented the most common market-accepted method for financing such assets.
•
•
In April 2006, we securitized Subprime Portfolio I. The loans were sold to a securitization trust, of which 80% were
treated as a sale, which is an off-balance sheet financing as described in “– Liquidity and Capital Resources.”
In July 2007, we securitized Subprime Portfolio II. The loans were sold to a securitization trust, of which 90% were
treated as a sale, which is an off-balance sheet financing as described in “– Liquidity and Capital Resources.”
We have no obligation to repurchase any loans from either of our subprime securitizations. Therefore, it is expected that our
exposure to loss is limited to the carrying amount of our retained interests in the securitization entities, as described above.
A subsidiary of ours gave limited representations and warranties with respect to the second securitization; however, it has
no assets and does not have recourse to the general credit of Newcastle.
We also had the following arrangements which do not meet the definition of off-balance sheet arrangements, but do have
some of the characteristics of off-balance sheet arrangements.
• We have made investments in three unconsolidated subsidiaries, two of which are dormant at December 31, 2009. See
Note 3 to Part II, Item 8, “Financial Statements and Supplementary Data.”
In each case, our exposure to loss is limited to the carrying (fair) value of our investment.
Contractual Obligations
As of December 31, 2009, we had the following material contractual obligations (payments in thousands):
Contract
Terms
CDO bonds payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Other bonds payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Repurchase agreements
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Junior subordinated notes
payable
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
48
Interest rate swaps, treated as
hedges
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Non-hedge derivative obligations
Described under Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk”
Management agreement
Our manager is paid an annual management fee of 1.5% of our gross equity, as
defined, an expense reimbursement, and incentive compensation equal to 25%
of our AFFO above a certain threshold. For more information on this
agreement, as well as historical amounts earned, see Note 10 to Part II, Item 8,
“Financial Statements and Supplementary Data.” As a result of not meeting the
incentive compensation threshold, the incentive compensation to the Manager
has been discontinued for an indeterminate period of time.
Subprime loan securitization
We entered into the securitization of Subprime Portfolios I and II as described
under “– Liquidity and Capital Resources.”
Loan servicing agreements
Trustee agreements
We are a party to servicing agreements with respect to our residential mortgage
loans, including manufactured housing loans and subprime mortgage loans. We
pay annual servicing fees generally equal to 0.375% of the outstanding face
amount of the residential mortgage loans, and 1.00% and 0.625% of the
outstanding face amount of the two portfolios of manufactured housing loans,
respectively. We also pay an incentive fee for one of the portfolios of
manufactured housing loans if the performance of the loans meets certain
thresholds.
We have entered into trustee agreements in connection with our securitized
investments, primarily our CDOs. We pay annual fees of between 0.015% and
0.020% of the outstanding face amount of the CDO bonds under these
agreements.
Contract
CDO bonds payable (1) (4)
Other bonds payable (1)
Repurchase agreements (1) (2)
Financing of subprime mortgage loans subject
to future repurchase (3)
Junior subordinated notes payable (1) (4)
Interest rate swaps, treated as hedges (5)
Non-hedge derivative obligations (6)
Management agreement (7)
Subprime loan securitization
Loan servicing agreements
Trustee agreements
Total
Fixed and Determinable Payments Due by Period
2010
2011-2012
2013-2014
Thereafter
Total
$
32,349
120,018
71,309
$
60,910
188,944
-
$
54,573
-
-
$
4,954,933
-
-
$
5,102,765
308,962
71,309
N/A
3,338
-
29,117
17,470
*
*
*
273,601
$
N/A
15,890
-
-
34,939
*
*
*
300,683
$
N/A
15,890
-
-
34,939
*
*
*
105,402
$
N/A
269,213
178,037
-
436,738
*
*
*
5,838,921
$
N/A
304,331
178,037
29,117
524,086
*
*
*
6,518,607
$
* These contracts do not have fixed and determinable payments.
(1) Includes interest based on rates existing at December 31, 2009 and assuming no prepayments. Obligations that are repayable prior to maturity at the
option of Newcastle are reflected at their contractual maturity dates.
(2) Repurchase agreements, which have not been term financed, and mature within one year of our financial statement date, are included in this table
assuming no interest.
(3) These obligations represent the related financing on the loans which are subject to future repurchase by Newcastle and are offset by the amount of
(4)
such loans. See Note 5 to Part II, Item 8, “Financial Statements and Supplementary Data”.
In February 2010, we completed an exchange of $51.9 million of junior subordinated notes due April 2035 for approximately $37.6 million face
amount of CDO securities issued by Newcastle and approximately $9.8 million of cash held by Newcastle.
(5) Primarily all of these agreements are held within our non-recourse financing structures. The amounts reflected assume that these agreements are
terminated at their December 31, 2009 fair value and paid at the contractual maturity of the related financing.
(6) The amounts reflected assume that these agreements are terminated at their December 31, 2009 fair value on January 1, 2010.
(7) Amounts reflect base management fees for the next 30 years assuming no change in gross equity, as defined, from December 31, 2009.
Inflation
We believe that our risk of increases in market interest rates on our floating rate debt as a result of inflation is largely offset
by our use of match funding and hedging instruments as described above. See Part II, Item 7A, "Quantitative and
Qualitative Disclosure About Market Risk — Interest Rate Exposure'' below.
49
Adjusted Funds from Operations
We believe Adjusted Funds from Operations (AFFO) is one appropriate measure of the operating performance of real estate
companies. We also believe that AFFO is an appropriate supplemental disclosure of operating performance for a REIT.
Furthermore, AFFO is used to compute our incentive compensation to our manager. AFFO, for our purposes, represents
net income available for common stockholders (computed in accordance with GAAP), excluding extraordinary items, plus
depreciation of our operating real estate, and after adjustments for unconsolidated subsidiaries, if any. We consider gains
and losses on resolution of our investments to be a normal part of our recurring operations and, therefore, do not exclude
such gains and losses when arriving at AFFO. This is the one difference between our definition of AFFO and the National
Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO, which excludes gains and losses.
Adjustments for unconsolidated subsidiaries, if any, are calculated to reflect AFFO on the same basis. AFFO does not
represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an
alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of
liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of AFFO may be different
from the calculation used by other companies and, therefore, comparability may be limited.
Adjusted Funds from Operations (AFFO) is calculated as follows (unaudited) (in thousands):
Income (loss) applicable to common stockholders
Operating real estate depreciation
Accumulated depreciation on operating real estate sold
Adjusted Funds from operations (AFFO)
2009
(223,405)
-
(124)
(223,529)
$
$
For the Year Ended December 31,
2008
(2,998,853)
$
$
2007
-
(5,223)
(3,004,076)
$
(78,097)
1,121
-
(76,976)
$
Adjusted funds from operations was derived from our segments as follows (unaudited) (in thousands):
Book Equity
December 31, 2009
AFFO for the Year Ended
December 31, 2009
CDOs
Other non-recourse
Recourse
Unlevered
Unallocated (1)
Total (2)
$
(990,713)
13,462
2,873
6,824
(190,912)
(1,158,466)
Preferred stock
Accumulated depreciation
Accumulated other comprehensive income (loss)
Net GAAP equity
152,500
(868)
(633,818)
(1,640,652)
$
$
$
(163,461)
38,610
(42,211)
(8,186)
(48,281)
(223,529)
(1) Unallocated AFFO represents ($8.2 million) of interest expense on our junior subordinated notes payable, ($13.5 million) of preferred
(2)
dividends and ($26.6 million) of corporate general and administrative expenses and management fees.
Invested common equity is equal to GAAP equity excluding preferred stock, accumulated depreciation and accumulated other comprehensive
income (loss).
As a result of the effect of other-than-temporary impairment on our AFFO, we expect that there will be no incentive
compensation payable to our manager for an indeterminate amount of time.
Net Interest Income Less Expenses (Net of Preferred Dividends)
We believe that net interest income less expenses (net of preferred dividends) is an appropriate supplemental disclosure of
the operating performance for a mortgage REIT. Net interest income less expenses (net of preferred dividends) does not
represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an
alternative to net income as an indicator of our operating performance or as an alternative to cash flow as a measure of our
liquidity and is not necessarily indicative of cash available to fund cash needs. Our calculation of net interest income less
expenses (net of preferred dividends) may be different from the calculation used by other companies and, therefore,
comparability may be limited.
Income (loss) applicable to common stockholders
Add (Deduct):
Impairment
Other (income) loss
Loss from discontinued operations
Year Ended December 31,
2009
2008
2007
$
(223,405)
$
(2,998,853)
$
(78,097)
548,540
(227,399)
318
98,054
$
2,991,830
112,809
9,654
115,440
$
220,321
8,885
130
151,239
$
50
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market risk is the exposure to loss resulting from changes in interest rates, credit spreads, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks that we are exposed to are interest rate risk and credit spread
risk. These risks are highly sensitive to many factors, including governmental monetary and tax policies, domestic and
international economic and political considerations and other factors beyond our control. All of our market risk sensitive
assets, liabilities and derivative positions are for non-trading purposes only. For a further understanding of how market risk
may effect our financial position or operating results, please refer to Part II, Item 7, “Management’s Discussion and
Analysis of Financial Condition and Results of Operations – Application of Critical Accounting Policies.”
Interest Rate Exposure
Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our investments in two
distinct ways, each of which is discussed below.
First, changes in interest rates affect our net interest income, which is the difference between the interest income earned on
assets and the interest expense incurred in connection with our debt obligations and hedges.
Our general financing strategy focuses on the use of match funded structures, when appropriate and available. This means
that we seek to match the maturities of our debt obligations with the maturities of our assets to reduce the risk that we have
to refinance our liabilities prior to the maturities of our assets, and to reduce the impact of changing interest rates on our
earnings. In addition, we generally match fund interest rates on our assets with like-kind debt (i.e., fixed rate assets are
financed with fixed rate debt and floating rate assets are financed with floating rate debt), directly or through the use of
interest rate swaps, caps or other financial instruments (see below), or through a combination of these strategies, which we
believe allows us to reduce the impact of changing interest rates on our earnings.
However, increases in interest rates can nonetheless reduce our net interest income to the extent that we are not completely
match funded. Furthermore, a period of rising interest rates can negatively impact our return on certain floating rate
investments. Although these investments may be financed with floating rate debt, the interest rate on the debt may reset
prior to, and in some cases more frequently than, the interest rate on the assets, causing a decrease in return on equity
during a period of rising interest rates.
As of December 31, 2009, a 100 basis point increase in short term interest rates would increase our earnings by
approximately $1.9 million per annum, assuming a static portfolio of current investments and financings.
Second, changes in the level of interest rates also affect the yields required by the marketplace on debt. Increasing interest
rates would decrease the value of the fixed rate assets we hold at the time because higher required yields result in lower
prices on existing fixed rate assets in order to adjust their yield upward to meet the market.
Changes in unrealized gains or losses resulting from changes in market interest rates do not directly affect our cash flows,
or our ability to pay a dividend, as the related assets are expected to be held and their fair value is not directly elevant to
their underlying cash flows. Our assets are largely financed to maturity through long term CDO financings that are not
redeemable as a result of book value changes. As long as these fixed rate assets continue to perform as expected, our cash
flows from these assets would not be affected by increasing interest rates. Changes in unrealized gains or losses would
impact our ability to realize gains on existing investments if they were sold. Furthermore, with respect to changes in
unrealized gains or losses on investments which are carried at fair value, changes in unrealized gains or losses would
impact our net book value and, in the cases of impaired assets and non-hedge derivatives, our net income (loss).
Changes in the value of our assets could affect our ability to borrow and access capital. Also, if the value of our assets
subject to short term financing were to decline, it could cause us to fund margin and affect our ability to refinance such
assets upon the maturity of the related financings, adversely impacting our rate of return on such securities.
As of December 31, 2009, a 100 basis point change in short term interest rates would impact our net book value by
approximately $34.0 million, assuming a static portfolio of current investments and financings.
Interest rate swaps are agreements in which a series of interest rate flows are exchanged with a third party (counterparty)
over a prescribed period. The notional amount on which swaps are based is not exchanged. In general, our swaps are “pay
fixed” swaps involving the exchange of floating rate interest payments from the counterparty for fixed interest payments
from us. This can effectively convert a floating rate debt obligation into a fixed rate debt obligation. Interest rate swaps
may be subject to margin calls.
Similarly, an interest rate cap or floor agreement is a contract in which we purchase a cap or floor contract on a notional
face amount. We will make an up-front payment to the counterparty for which the counterparty agrees to make future
payments to us should the reference rate (typically LIBOR) rise above (cap agreements) or fall below (floor agreements)
the “strike” rate specified in the contract. Payments on an annualized basis will equal the contractual notional face amount
multiplied by the difference between the actual reference rate and the contracted strike rate.
51
While a REIT may utilize these types of derivative instruments to hedge interest rate risk on its liabilities or for other
purposes, such derivative instruments could generate income that is not qualified income for purposes of maintaining REIT
status. As a consequence, we may only engage in such instruments to hedge such risks within the constraints of
maintaining our standing as a REIT. We do not enter into derivative contracts for speculative purposes nor as a hedge
against changes in credit risk.
Our hedging transactions using derivative instruments also involve certain additional risks such as counterparty credit risk,
the enforceability of hedging contracts and the risk that unanticipated and significant changes in interest rates will cause a
significant loss of basis in the contract. There can be no assurance that we will be able to adequately protect against the
foregoing risks and will ultimately realize an economic benefit that exceeds the related amounts incurred in connection with
engaging in such hedging strategies.
Credit Spread Exposure
Credit spreads measure the yield demanded on loans and securities by the market based on their credit relative to U.S.
Treasuries, for fixed rate credit, or LIBOR, for floating rate credit. Our fixed rate loans and securities are valued based on a
market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Our floating rate loans and
securities are valued based on a market credit spread over LIBOR. Excessive supply of such loans and securities combined
with reduced demand will generally cause the market to require a higher yield on such loans and securities, resulting in the
use of a higher (or “wider”) spread over the benchmark rate to value them.
Widening credit spreads would result in higher yields being required by the marketplace on loans and securities. This
widening would reduce the value of the loans and securities we hold at the time because higher required yields result in
lower prices on existing securities in order to adjust their yield upward to meet the market. The effects of such a decrease in
values on our financial position, results of operations and liquidity are discussed above under “- Interest Rate Exposure.”
As of December 31, 2009, a 25 basis point movement in credit spreads would impact our net book value by approximately
$19.7 million, assuming a static portfolio of current investments and financings, but would not directly affect our earnings
or cash flow.
Our financing strategy is dependent on our ability to place the match funded debt we use to finance our investments at rates
that provide a positive net spread. Currently, spreads for such liabilities have widened and demand for such liabilities has
become extremely limited, therefore restricting our ability to execute future financings.
In an environment where spreads are tightening, if spreads tighten on the assets we purchase to a greater degree than they
tighten on the liabilities we issue, our net spread will be reduced.
Credit Risk
In addition to the above described market risks, Newcastle is subject to credit risk.
Credit risk refers to the ability of each individual borrower under our loans and securities to make required interest and
principal payments on the scheduled due dates. The commercial mortgage and asset backed securities we invest in are
generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of
one or more subordinate classes of securities or other form of credit support (which absorbs losses before the securities in
which we invest) within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect
comparable credit risk. As a result of the current challenging economic conditions and illiquidity in the markets, the value
of the subordinated securities has generally been reduced or, in some cases, eliminated, which could leave our securities
economically in a first loss position. We also invest in loans and securities which represent “first loss” pieces; in other
words, they do not benefit from credit support although we believe at acquisition they predominantly benefit from
underlying collateral value in excess of their carrying amounts.
We seek to reduce credit risk by actively monitoring our asset portfolio and the underlying credit quality of our holdings
and, where appropriate and achievable, repositioning our investments to upgrade their credit quality. In the event of a
significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result
in credit losses that would adversely affect our liquidity and operating results. As described above in “- Market
Considerations” and elsewhere in this annual report, adverse market and credit conditions have resulted in our recording of
other-than-temporary impairment in certain securities and loans.
Margin
Certain of our derivatives, and the financing on our FNMA/FHLMC securities, are subject to margin calls based on the
value of such investments. We seek to maintain adequate cash reserves and other sources of available liquidity to meet any
margin calls resulting from decreases in value related to a reasonably possible (in the opinion of management) change in
interest rates.
52
Interest Rate and Credit Spread Risk Sensitive Instruments and Fair Value
Our holdings of such financial instruments, and their fair values and the estimation methodology thereof, are detailed in
Note 7 to Part II, Item 8, “Financial Statements and Supplementary Data.” For information regarding the impact of
prepayment, reinvestment, and expected loss factors on the timing of realization of our investments, please refer to the
consolidated financial statements included therein. For information regarding the impact of changes in these factors on the
value of securities valued with internal models, see Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Critical Accounting Policies.”
We note that the values of our investments in real estate securities, loans and derivative instruments are sensitive to changes
in market interest rates, credit spreads and other market factors. The value of these investments can vary, and has varied,
materially from period to period.
Trends
See “– Market Considerations” above for a further discussion of recent trends and events affecting our liquidity, unrealized
gains and losses.
53
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements:
Report of Independent Registered Public Accounting Firm
Report on Internal Control Over Financial Reporting of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2009 and December 31, 2008
Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2009, 2008 and 2007
Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007
Notes to Consolidated Financial Statements
All schedules have been omitted because either the required information is included in our consolidated financial
statements and notes thereto or it is not applicable.
54
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Newcastle Investment Corp.
We have audited the accompanying consolidated balance sheets of Newcastle Investment Corp. and subsidiaries (the
''Company'') as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders' equity,
and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial
position of Newcastle Investment Corp. and subsidiaries at December 31, 2009 and 2008, and the consolidated results of
their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with
U.S. generally accepted accounting principles.
As discussed in Notes 2 and 4 to the consolidated financial statements, the Company changed its method of accounting for
other-than-temporary impairment with the adoption of the guidance originally issued in FASB Statement No.115-2 and
124-2, Recognition and Presentation of Other-Than-Temporary Impairments (codified in FASB ASC Topics 320, 310-30,
and 325-40) effective April 1, 2009.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), Newcastle Investment Corp.’s internal control over financial reporting as of December 31, 2009, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated February 19, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New York, New York
February 19, 2010
55
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Newcastle Investment Corp.
We have audited Newcastle Investment Corp. and subsidiaries’ internal control over financial reporting as of December 31,
2009 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Newcastle Investment Corp. and subsidiaries’
management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal
Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and
that receipts and expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Newcastle Investment Corp. and subsidiaries maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2009, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of Newcastle Investment Corp. and subsidiaries as of December 31, 2009 and 2008,
and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the
period ended December 31, 2009 of Newcastle Investment Corp. and subsidiaries and our report dated February 19, 2010
expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New York, New York
February 19, 2010
56
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
Assets
Real estate securities, available for sale - Note 4
Real estate related loans held for sale, net - Note 5
Residential mortgage loans held for sale, net - Note 5
Subprime mortgage loans subject to call option - Note 5
Investments in unconsolidated subsidiaries - Note 3
Operating real estate, held for sale - Note 6
Cash and cash equivalents
Restricted cash
Receivables and other assets
Liabilities and Stockholders' Equity (Deficit)
Liabilities
CDO bonds payable - Note 8
Other bonds payable - Note 8
Repurchase agreements - Note 8
Financing of subprime mortgage loans subject to call option - Notes 5 and 8
Junior subordinated notes payable - Note 8
Derivative liabilities - Note 2
Due to affiliates - Note 10
Accrued expenses and other liabilities
Commitments and contingencies - Notes 9, 10 and 11
Stockholders' Equity (Deficit)
Preferred stock, $0.01 par value, 100,000,000 shares authorized,
2,500,000 shares of 9.75% Series B Cumulative Redeemable Preferred Stock,
1,600,000 shares of 8.05% Series C Cumulative Redeemable Preferred Stock, and
2,000,000 shares of 8.375% series D Cumulative Redeemable Preferred Stock, liquidation
preference $25.00 per share, issued and outstanding
Common stock, $0.01 par value, 500,000,000 shares authorized, 52,912,513
and 52,789,050 shares issued and outstanding at December 31, 2009 and 2008, respectively
Additional paid-in capital
Accumulated deficit - Note 2
Accumulated other comprehensive income (loss) - Note 2
See notes to consolidated financial statements.
December 31,
2009
2008
$
1,830,795
$
1,668,748
573,862
383,647
403,006
193
9,966
68,300
205,378
39,481
843,212
409,632
398,026
384
11,866
49,746
44,282
47,727
$
3,514,628
$
3,473,623
$
4,058,928
$
4,359,981
303,697
71,309
403,006
103,264
207,154
1,497
6,425
380,620
276,472
398,026
100,100
333,977
1,532
16,447
5,155,280
5,867,155
152,500
152,500
529
1,033,520
(2,193,383)
(633,818)
(1,640,652)
528
1,033,416
(3,272,403)
(307,573)
(2,393,532)
$
3,514,628
$
3,473,623
57
10,394
7,325
202,602
-
220,321
(16,718)
13,994
(15,032)
(13,237)
5,390
(8,885)
9,719
5,860
17,645
6,209
291
39,724
(65,327)
(130)
(65,457)
(12,640)
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share data)
Interest income
Interest expense
Net interest income
Impairment
Provision for credit losses on loan pools - Note 5
Valuation allowance on loans - Note 5
Other-than-temporary impairment on securities- Note 4
Portion of other-than-temporary impairment on securities recognized
in other comprehensive income - Note 4
Year Ended December 31,
2009
2008
2007
$
361,866
218,410
143,456
$
468,867
307,303
161,564
$
680,535
476,932
203,603
-
15,007
603,768
(70,235)
548,540
8,457
985,677
1,997,696
-
2,991,830
Net interest income (loss) after impairment
(405,084)
(2,830,266)
Other Income (Loss)
Gain (loss) on settlement of investments, net - Note 2
Gain (loss) on extinguishment of debt - Note 8
Other income (loss), net - Note 2
Equity in earnings (losses) of unconsolidated subsidiaries - Note 3
Expenses
Loan and security servicing expense
General and administrative expense
Management fee to affiliate - Note 10
Incentive compensation to affiliate - Note 10
Depreciation and amortization
Income (loss) from continuing operations
Income (loss) from discontinued operations - Note 6
Net Income (Loss)
Preferred dividends
11,438
215,279
262
420
227,399
5,034
8,609
17,968
-
290
31,901
(209,586)
(318)
(209,904)
(13,501)
(58,668)
13,824
(76,122)
8,157
(112,809)
6,649
7,297
18,388
-
289
32,623
(2,975,698)
(9,654)
(2,985,352)
(13,501)
Income (Loss) Applicable To Common Stockholders
$
(223,405)
$
(2,998,853)
$
(78,097)
Income (Loss) Per Share of Common Stock
Basic
Diluted
Income (loss) from continuing operations per share of common
stock, after preferred dividends
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
Weighted Average Number of Shares of Common Stock Outstanding
Basic
Diluted
$
(4.23)
$
(56.81)
$
(1.52)
$
(4.23)
$
(56.81)
$
(1.52)
$
(4.22)
$
(56.63)
$
(1.52)
$
(4.22)
$
(56.63)
$
(1.52)
$
(0.01)
$
(0.18)
$
(0.00)
$
(0.01)
$
(0.18)
$
(0.00)
52,863,993
52,863,993
52,785,305
52,785,305
51,369,486
51,369,486
Dividends Declared per Share of Common Stock
$
-
$
0.750
$
2.850
See notes to consolidated financial statements.
58
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
Stockholders' equity (deficit) - December 31, 2008
Issuance of common stock to directors
Reclassification adjustment upon adoption of new impairment guidance
Comprehensive income:
Net income (loss)
Net unrealized gain on securities
Reclassification of net realized loss on securities into earnings
Net unrealized gain on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated as
cash flow hedges into earnings
Total comprehensive income (loss)
Stockholders' equity (deficit) - December 31, 2009
Stockholders' equity (deficit) - December 31, 2007
Dividends declared
Issuance of common stock to directors
Comprehensive income:
Net income (loss)
Net unrealized gain (loss) on securities
Reclassification of net realized loss on securities into earnings
Foreign currency translation
Net unrealized (loss) on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated
cash flow hedges into earnings
Total comprehensive income (loss)
Stockholders' equity (deficit) - December 31, 2008
Continued on next page.
Preferred Stock
Common Stock
Shares
Amount
Shares
6,100,000
-
-
-
-
-
-
-
$
152,500
-
-
52,789,050
123,463
-
-
-
-
-
-
-
-
-
-
-
Amount
$
528
1
-
-
-
-
-
-
Additional
Paid in Capital
Accumulated
Deficit
Accumulated
Other Comp.
Income (Loss)
Total Stock-
holders' Equity
(Deficit)
$
1,033,416
104
-
$
(3,272,403)
-
$
(307,573)
-
1,288,924
(1,288,924)
$
(2,393,532)
105
-
-
-
-
-
-
(209,904)
-
-
-
-
306,626
522,625
123,926
(209,904)
306,626
522,625
123,926
-
9,502
9,502
752,775
(1,640,652)
$
6,100,000
$
152,500
52,912,513
$
529
$
1,033,520
$
(2,193,383)
$
(633,818)
6,100,000
-
-
$
152,500
-
-
52,779,179
-
9,871
$
528
-
-
$
1,033,326
-
90
$
(236,213)
(50,838)
-
$
(502,516)
-
-
$
447,625
(50,838)
90
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
(2,985,352)
-
-
-
-
-
(1,587,049)
2,001,786
(5,037)
(230,891)
(2,985,352)
(1,587,049)
2,001,786
(5,037)
(230,891)
-
16,134
16,134
(2,790,409)
(2,393,532)
$
6,100,000
$
152,500
52,789,050
$
528
$
1,033,416
$
(3,272,403)
$
(307,573)
59
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
Stockholders' equity - December 31, 2006
Dividends declared
Issuance of common stock
Issuance of common stock to directors
Exercise of common stock options
Issuance of preferred stock
Comprehensive income:
Net income (loss)
Net unrealized (loss) on securities
Reclassification of net realized (gain) on securities into earnings
Foreign currency translation
Net unrealized (loss) on derivatives designated as cash flow hedges
Reclassification of net realized loss on derivatives designated
cash flow hedges into earnings
Total comprehensive (loss)
Stockholders' equity - December 31, 2007
Preferred
Common
Shares
Amount
Shares
Amount
4,100,000
-
-
-
-
2,000,000
$
102,500
-
-
-
-
50,000
45,713,817
-
6,980,000
2,164
83,198
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
457
-
70
-
1
-
-
-
-
-
-
-
Additional
Paid in Capital
Accumulated
Deficit
$
833,887
-
199,707
60
1,442
(1,770)
$
(10,848)
(159,908)
-
-
-
-
Accumulated
Other Comp.
Income
$
75,984
-
-
-
-
-
Total Stock-
holders' Equity
$
1,001,980
(159,908)
199,777
60
1,443
48,230
-
-
-
-
-
-
(65,457)
-
-
-
-
-
(429,897)
(20,830)
3,019
(133,004)
(65,457)
(429,897)
(20,830)
3,019
(133,004)
-
2,212
2,212
(643,957)
447,625
$
6,100,000
$
152,500
52,779,179
$
528
$
1,033,326
$
(236,213)
$
(502,516)
60
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Cash Flows From Operating Activities
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating
activities (inclusive of amounts related to discontinued operations):
Depreciation and amortization
Accretion of discount and other amortization
Deferred rent
Provision for credit losses on loan pools - Note 5
Valuation allowance on loans - Note 5
Non-cash directors' compensation
(Gain) loss on sale of investments
Unrealized (gain) loss on non-hedge derivatives and hedge ineffectiveness
Other-than-temporary impairment on securities- Note 4
Impairment on real estate held for sale
(Gain) loss on extinguishment of debt - Note 8
Equity in (earnings) losses of unconsolidated subsidiaries
Distributions of earnings from unconsolidated subsidiaries
Purchase of loans held for sale - Note 5
Sale of loans held for sale - Note 5
Change in:
Restricted cash
Receivables and other assets
Due to affiliates
Accrued expenses and other liabilities
Net cash provided by (used in) operating activities
Cash Flows From Investing Activities
Purchase of real estate securities
Proceeds from sale of real estate securities
Purchase of and advances on loans
Proceeds from settlement of loans
Principal fundings on loan commitments
Repayments of loan and security principal
Margin received on derivative instruments
Return of margin on derivative instruments
Margin deposits on total rate of return swaps (treated as derivative instruments)
Return of margin deposits on total rate of return swaps
(treated as derivative instruments)
Net proceeds (payments) from termination of derivative instruments
Payments on settlement of derivative instruments
Purchase and improvement of real estate held for sale
Proceeds from sale of real estate held for sale
Contributions to unconsolidated subsidiaries
Distributions of capital from unconsolidated subsidiaries
Change in restricted cash from investment in new CDOs
Net cash provided by (used in) investing activities
Continued on next page.
Year Ended December 31,
2009
2008
2007
$
(209,904)
$
(2,985,352)
$
(65,457)
295
(33,912)
-
-
15,007
105
(11,438)
55
533,533
550
(215,279)
(420)
420
-
-
1,400
4,370
(35)
(584)
84,163
(1,800)
136,000
(14,588)
-
-
93,401
3,550
-
-
37
-
(11,610)
-
1,350
-
91
-
206,431
637
(32,418)
183
8,457
985,677
90
44,580
94,011
1,997,696
10,049
(13,824)
(8,157)
10,261
-
-
5,571
13,104
(6,209)
(6,182)
118,174
(67,733)
1,428,524
-
33,978
(1,180)
310,548
105,576
(92,196)
(59,194)
103,028
-
(101,250)
(603)
11,226
-
21,988
-
1,692,712
1,412
(26,709)
234
10,723
7,325
60
(14,218)
14,586
202,602
-
10,278
(5,390)
3,286
(1,089,202)
969,747
(2,106)
(10,879)
(5,724)
(7,078)
(6,510)
(448,684)
237,892
(941,045)
29,197
-
1,169,032
98,744
(129,757)
(60,085)
63,941
26,807
-
(2,964)
-
(379)
874
(9,601)
33,972
61
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Cash Flows From Financing Activities
Issuance of CDO bonds payable
Repayments and repurchases of CDO bonds payable
Repayments of other bonds payable
Repayments of notes payable
Borrowings under repurchase agreements
Repayments of repurchase agreements
Margin deposits under repurchase agreement
Return of margin deposits under repurchase agreements
Issuance of repurchase agreements subject to ABCP facility
Repayments of repurchase agreements subject to ABCP facility
Draws under credit facility
Repayments of credit facility
Issuance of common stock
Costs related to issuance of common stock
Exercise of common stock options
Issuance of preferred stock
Costs related to issuance of preferred stock
Dividends paid
Payment of deferred financing costs
Restricted cash returned from refinancing activities
Net cash provided by (used in) financing activities
Net Increase (Decrease) in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest expense
Cash paid (refunded) during the period for federal excise tax
Supplemental Schedule of Non-cash Investing and Financing Activities
Issuance of junior subordinated notes in exchange of previously issued trust
preferred securities
Common stock dividends declared but not paid
Preferred stock dividends declared but not paid
Foreclosure of loans
Acquisition and financing of loans subject to call option
Retained bonds and equity in securitization
See notes to consolidated financial statements.
Year Ended December 31,
2009
2008
2007
-
(71,763)
(77,360)
-
-
(205,163)
7,586
(7,303)
-
-
-
-
-
-
-
-
-
-
(200)
82,163
(272,040)
18,554
49,746
68,300
$
-
(334,140)
(167,542)
-
85,749
(1,444,163)
(109,196)
114,371
-
-
-
-
-
-
-
-
-
(91,087)
(337)
129,289
(1,817,056)
(6,170)
55,916
49,746
$
1,835,071
(1,443,138)
(130,587)
(128,866)
4,951,437
(4,077,421)
(5,457)
-
247,409
(1,391,158)
382,800
(476,600)
200,165
(358)
1,443
50,000
(1,770)
(152,752)
(2,273)
165,138
23,083
50,545
5,371
55,916
$
$
$
161,254
(316)
$
$
271,845
316
$
447,212
$
-
$
100,000
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
38,001
$
2,250
$
285
$
102,381
$
-
$
-
$
81,677
62
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
1. ORGANIZATION
Newcastle Investment Corp. (and its subsidiaries, “Newcastle”) is a Maryland corporation that was formed in 2002.
Newcastle conducts its business through four primary segments: (i) investments financed with non-recourse
collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments
financed with recourse debt, including FNMA / FHLMC securities, and (iv) unlevered investments.
The following table presents information on shares of Newcastle’s common stock issued subsequent to its formation:
Year
Shares Issued
Range of Issue
Prices (1)
Net Proceeds
(millions)
Formation - 2004
2005
2006
2007
2008
2009
December 31, 2009
39,859,481
4,053,928
1,800,408
7,065,362
9,871
123,463
52,912,513
$29.60
$29.42
$27.75-$31.30
N/A
N/A
$108.2
$51.2
$201.3
$0.1
$0.1
(1) Exclude prices of shares issued pursuant to the exercise of options and of shares issued to our independent directors.
Newcastle is organized and conducts its operations to qualify as a real estate investment trust (“REIT”) under the
Internal Revenue Code of 1986, as amended (the “Code”). As such, Newcastle will generally not be subject to U.S.
federal corporate income tax on that portion of its net income that is distributed to stockholders if it distributes at least
90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements.
Newcastle is party to a management agreement (the “Management Agreement”) with FIG LLC (the “Manager”), an
affiliate of Fortress Investment Group LLC, under which the Manager advises Newcastle on various aspects of its
business and manages its day-to-day operations, subject to the supervision of Newcastle’s board of directors. For its
services, the Manager receives an annual management fee and incentive compensation, both as defined in the
Management Agreement. For a further discussion of the Management Agreement, see Note 10.
Approximately 3.8 million shares of Newcastle’s common stock were held by the Manager, through its affiliates, and
principals of Fortress at December 31, 2009. In addition, the Manager, through its affiliates, held options to purchase
approximately 1.7 million shares of Newcastle’s common stock at December 31, 2009.
63
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Basis of Accounting – The accompanying consolidated financial statements are prepared in accordance with U.S.
generally accepted accounting principles ("GAAP''). The consolidated financial statements include the accounts of
Newcastle and its consolidated subsidiaries. All significant intercompany transactions and balances have been
eliminated. Newcastle consolidates those entities in which it has an investment of 50% or more and has control over
significant operating, financial and investing decisions of the entity as well as those entities deemed to be variable
interest entities (“VIEs”) in which Newcastle is determined to be the primary beneficiary. VIEs are defined as entities
in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.
A VIE is required to be consolidated by its primary beneficiary, and only its primary beneficiary, which is defined as
the party who will absorb a majority of the VIE’s expected losses or receive a majority of the expected residual returns
as a result of holding variable interests. Newcastle’s CDO subsidiaries (Note 3 and 8) and our manufactured housing
loan financing structures are special purpose entities which are considered VIEs of which Newcastle is the primary
beneficiary. Therefore, the debt issued by such entities is considered a non-recourse secured borrowing of Newcastle.
The subprime securitization trusts (Note 5) are exempt from consolidation as VIEs through December 31, 2009 since
they are qualified special purpose entities.
For entities over which Newcastle exercises significant influence, but which do not meet the requirements for
consolidation, Newcastle uses the equity method of accounting whereby it records its share of the underlying income of
such entities. Newcastle owns an equity method investment in a limited liability company (Note 3) which is an
investment company and therefore maintains its financial records on a fair value basis. Newcastle has retained such
accounting relative to its investment in this company.
Change in Presentation
Newcastle has changed the format of its consolidated statements of operations for all periods presented to be more
consistent with the provisions of Article 9 of Regulation S-X. Article 9 of Regulation S-X is applicable to bank holding
companies and Newcastle believes that, as a finance company, Article 9’s provisions are more closely aligned with its
operations than those in Article 5, which applies to commercial and industrial companies. This change in format did
not have any effect on any of the reported line items within the statements of operations, or on net income (loss) or net
income (loss) per share.
Risks and Uncertainties ⎯ In the normal course of business, Newcastle encounters primarily two significant types of
economic risk: credit and market. Credit risk is the risk of default on Newcastle’s securities, loans, derivatives, and
leases that results from a borrower's, derivative counterparty's or lessee's inability or unwillingness to make
contractually required payments. Market risk reflects changes in the value of investments in securities, loans and
derivatives or in real estate due to changes in interest rates, spreads or other market factors, including the value of the
collateral underlying loans and securities and the valuation of real estate held by Newcastle. Management believes that
the carrying values of its investments are reasonable taking into consideration these risks along with estimated
collateral values, payment histories, and other borrower information.
Additionally, Newcastle is subject to significant tax risks. If Newcastle were to fail to qualify as a REIT in any taxable
year, Newcastle would be subject to U.S. federal corporate income tax (including any applicable alternative minimum
tax), which could be material. Unless entitled to relief under certain statutory provisions, Newcastle would also be
disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost.
Use of Estimates ⎯ The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Comprehensive Income ⎯ Comprehensive income is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances, excluding those resulting from investments by and
distributions to owners. For Newcastle’s purposes, comprehensive income represents net income, as presented in the
statements of operations, adjusted for unrealized gains or losses on securities available for sale and derivatives
designated as cash flow hedges.
64
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
The following table summarizes Newcastle’s accumulated other comprehensive income:
Net unrealized gains (losses) on securities
Net unrealized gains (losses) on derivatives designated as cash flow hedges
December 31,
2009
2008
$
(452,923)
$
6,750
(180,895)
(314,323)
Accumulated other comprehensive income (loss)
$
(633,818)
$
(307,573)
REVENUE RECOGNITION
Real Estate Securities and Loans Receivable ⎯ Newcastle invests in securities, including commercial mortgage
backed securities, senior unsecured debt issued by property REITs, real estate related asset backed securities and
FNMA/FHLMC securities. Newcastle also invests in loans, including real estate related loans, commercial mortgage
loans, residential mortgage loans, manufactured housing loans and subprime mortgage loans. Newcastle determines at
acquisition whether loans will be aggregated into pools based on common risk characteristics (credit quality, loan type,
and date of origination or acquisition); loans aggregated into pools are accounted for as if each pool were a single loan.
Loans receivable are presented in the consolidated balance sheet net of any unamortized discount (or gross of any
unamortized premium) and an allowance for loan losses. Discounts or premiums are accreted into interest income on
an effective yield or “interest” method, based upon a comparison of actual and expected cash flows, through the
expected maturity date of the security or loan. Depending on the nature of the investment, changes to expected cash
flows may result in a prospective change to yield or a retrospective change which would include a catch up adjustment.
For loans acquired at a discount for credit quality, the difference between contractual cash flows and expected cash
flows at acquisition is not accreted (nonaccretable difference). Newcastle discontinued the accretion of discounts and
amortization of premium of all loans since December 31, 2008 as they were reclassified as held for sale.Interest income
with respect to non-discounted securities or loans is recognized on an accrual basis. Deferred fees and costs, if any, are
recognized as a reduction to the interest income over the terms of the securities or loans using the interest method.
Upon settlement of securities and loans, the excess (or deficiency) of net proceeds over the net carrying value of such
security or loan is recognized as a gain (or loss) in the period of settlement. Interest income includes prepayment
penalties received of $8.2 million, $0.0 million and $2.3 million in 2009, 2008, 2007, respectively.
Impairment of Securities and Loans ⎯ Newcastle continually evaluates securities and loans for impairment.
Securities and loans are considered to be other-than-temporarily impaired, for financial reporting purposes, generally
when it is probable that Newcastle will be unable to collect all principal or interest when due according to the
contractual terms of the original agreements, or, for securities or loans purchased at a discount for credit quality or that
represent retained beneficial interests in securitizations, when Newcastle determines that it is probable that it will be
unable to collect as anticipated. The evaluation of a security’s estimated cash flows includes the following, as
applicable: (i) review of the credit of the issuer or the borrower, (ii) review of the credit rating of the security, (iii)
review of the key terms of the security or loan, (iv) review of the performance of the loan or underlying loans,
including debt service coverage and loan to value ratios, (v) analysis of the value of the collateral for the loan or
underlying loans, (vi) analysis of the effect of local, industry and broader economic factors, and (vii) analysis of
historical and anticipated trends in defaults and loss severities for similar securities or loans. Furthermore, Newcastle
must have the intent and ability to hold loans whose fair value is below carrying value until such fair value recovers, or
until maturity, or else a write down to fair value must be recorded. Similarly for securities, Newcastle must record a
write down if we have the intent to sell a given security in an unrealized loss position, or if it is more likely than not
that we will be required to sell such a security. Upon determination of impairment, Newcastle establishes specific
valuation allowances for loans or records a direct write down for securities based on the estimated fair value of the
security or underlying collateral using a discounted cash flow analysis or based on an observable market value.
Newcastle also establishes allowances for estimated unidentified incurred losses on pools of loans. The allowance for
each loan is maintained at a level believed adequate by management to absorb probable losses, based on periodic
reviews of actual and expected losses. It is Newcastle’s policy to establish an allowance for uncollectible interest on
performing securities or loans that are past due more than 90 days or sooner when, in the judgment of management, the
probability of collection of interest is deemed to be insufficient to warrant further accrual. Upon such a determination,
those loans are deemed to be non-performing and put on nonaccrual status. Actual losses may differ from Newcastle’s
estimates. Newcastle may resume accrual of income on a security or loan if, in management’s opinion, full collection
is probable. Subsequent to a determination of impairment, and a related write down, income is accrued on an effective
yield method from the new carrying value to the related expected cash flows, with cash received treated as a reduction
of basis.
65
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Gain (Loss) on Settlement of Investments, Net and Other Income (Loss), Net – These items are comprised of the
following:
Gain (loss) on settlement of investments, net
Gain on settlement of real estate securities
Loss on settlement of real estate securities
Gain on disposition of loans held for sale
Loss on disposition of loans held for sale
Realized gain (loss) of termination of derivative instruments
Other gain (loss)
Other income (loss), net
Realized gain (loss) on total rate of return swaps
Unrealized gain (loss) on total rate of return swaps
Gain (loss) on non-hedge derivative instruments
Unrealized gain (loss) recognized at de-designation of hedges
Hedge ineffectiveness
Other income (loss)
EXPENSE RECOGNITION
Year-Ended December 31,
2009
2008
2007
$
29,663
(18,644)
526
(111)
4
-
$
12,555
(16,645)
1,434
(41,924)
(14,088)
-
$
20,545
(6,390)
-
-
(222)
61
$
11,438
$
(58,668)
$
13,994
-
$
-
15,446
(15,223)
(278)
317
$
(46,923)
-
(18,451)
(14,730)
180
3,802
-
$
(9,716)
6,059
(9,239)
(1,468)
1,127
$
262
$
(76,122)
$
(13,237)
Interest Expense ⎯ Newcastle finances its investments using both fixed and floating rate debt, including
securitizations, loans, repurchase agreements, and other financing vehicles. Certain of this debt has been issued at
discounts. Discounts are accreted into interest expense on the interest method through the expected maturity date of
the financing.
Deferred Costs and Interest Rate Cap Premiums ⎯ Deferred costs consist primarily of costs incurred in obtaining
financing which are amortized into interest expense over the term of such financing using the interest method. Interest
rate cap premiums, which are included in Derivative Assets, are amortized as described below.
Derivatives and Hedging Activities ⎯ All derivatives are recognized as either assets or liabilities on the balance sheet
and measured at fair value. Newcastle reports the fair value of derivative instruments gross of cash paid or received
pursuant to credit support agreements and fair value is reflected on a net counterparty basis when Newcastle believes a
legal right of offset exists under an enforceable netting agreement. Fair value adjustments affect either stockholders'
equity or net income depending on whether the derivative instrument qualifies as a hedge for accounting purposes and,
if so, the nature of the hedging activity. For those derivative instruments that are designated and qualify as hedging
instruments, Newcastle designates the hedging instrument, based upon the exposure being hedged, as either a cash flow
hedge, a fair value hedge or a hedge of a net investment in a foreign operation.
Derivative transactions are entered into by Newcastle solely for risk management purposes, except for total rate of
return swaps as described in Note 5. Such total rate of return swaps are essentially financings of certain reference
assets which are treated as derivatives for accounting purposes. The decision of whether or not a given
transaction/position (or portion thereof) is hedged is made on a case-by-case basis, based on the risks involved and
other factors as determined by senior management, including restrictions imposed by the Code among others. In
determining whether to hedge a risk, Newcastle may consider whether other assets, liabilities, firm commitments and
anticipated transactions already offset or reduce the risk. All transactions undertaken as hedges are entered into with a
view towards minimizing the potential for economic losses that could be incurred by Newcastle. Generally, all
derivatives entered into are intended to qualify as hedges under GAAP, unless specifically stated otherwise. To this
end, terms of hedges are matched closely to the terms of hedged items.
Description of the risks being hedged
1) Interest rate risk, existing debt obligations – Newcastle generally hedges the risk of interest rate fluctuations
with respect to its borrowings, regardless of the form of such borrowings, which require payments based on a
66
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
variable interest rate index. Newcastle generally intends to hedge only the risk related to changes in the
benchmark interest rate (LIBOR or a Treasury rate). In order to reduce such risks, Newcastle may enter into
swap agreements whereby Newcastle would receive floating rate payments in exchange for fixed rate
payments, effectively converting the borrowing to fixed rate. Newcastle may also enter into cap agreements
whereby, in exchange for a premium, Newcastle would be reimbursed for interest paid in excess of a certain
cap rate.
2) Interest rate risk, anticipated transactions – Newcastle may hedge the aggregate risk of interest rate
fluctuations with respect to anticipated transactions, primarily anticipated borrowings. The primary risk
involved in an anticipated borrowing is that interest rates may increase between the date the transaction
becomes probable and the date of consummation. Newcastle generally intends to hedge only the risk related to
changes in the benchmark interest rate (LIBOR or a Treasury rate). This is generally accomplished through
the use of interest rate swaps.
3) Interest rate risk, fair value of investments – Newcastle occasionally hedges the fair value of investments
acquired prior to such investments being included in a CDO financing (Note 8). The primary risk involved is
the risk that the fair value of such an investment will change between the acquisition date and the date the
terms of the related financing are “locked in.” Newcastle generally intends to hedge only the risk related to
changes in the benchmark interest rate (LIBOR or a Treasury rate). This is generally accomplished through
the use of interest rate swaps.
Cash flow hedges
To qualify for cash flow hedge accounting, interest rate swaps and caps must meet certain criteria, including (1) the
items to be hedged expose Newcastle to interest rate risk, (2) the interest rate swaps or caps are highly effective in
reducing Newcastle’s exposure to interest rate risk, and (3) with respect to an anticipated transaction, such transaction
is probable. Correlation and effectiveness are periodically assessed based upon a comparison of the relative changes in
the fair values or cash flows of the interest rate swaps and caps and the items being hedged or using regression analysis
on an ongoing basis to assess retrospective and prospective hedge effectiveness.
For derivative instruments that are designated and qualify as a cash flow hedge (i.e. hedging the exposure to variability
in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss, and net
payments received or made, on the derivative instrument are reported as a component of other comprehensive income
and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The
remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future
cash flows of the hedged item, if any, is recognized in current earnings during the period of change. The premiums
paid for interest rate caps, treated as cash flow hedges, are amortized into interest expense based on the estimated value
of such cap for each period covered by such cap.
With respect to interest rate swaps which have been designated as hedges of anticipated financings, periodic net
payments are recognized currently as adjustments to interest expense; any gain or loss from fluctuations in the fair
value of the interest rate swaps is recorded as a deferred hedge gain or loss in accumulated other comprehensive
income and treated as a component of the anticipated transaction. In the event the anticipated refinancing failed to
occur as expected, the deferred hedge credit or charge would be recognized immediately in earnings. Newcastle’s
hedges of such financings were terminated upon the consummation of such financings.
Newcastle has dedesignated certain of its hedge derivatives, and in some cases redesignated all or a portion thereof as
hedges. As a result of these dedesignations, in the cases where the originally hedged items were still owned by
Newcastle, the unrealized gain or loss was recorded in OCI as a deferred hedge gain or loss and is being amortized
over the life of the hedged item.
Fair Value Hedges
Any unrealized gains or losses, as well as net payments received or made, on these derivative instruments are recorded
currently in earnings, as are any unrealized gains or losses on the associated hedged items related to changes in interest
rates.
67
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Non-Hedge Derivatives
With respect to interest rate swaps and caps that have not been designated as hedges, any net payments under, or
fluctuations in the fair value of, such swaps and caps have been recognized currently in Other Income (Loss).
Newcastle’s derivative financial instruments contain credit risk to the extent that its bank counterparties may be unable
to meet the terms of the agreements. Newcastle reduces such risk by limiting its counterparties to major financial
institutions. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored.
Management does not expect any material losses as a result of default by other parties. Newcastle does not require
collateral; however, Newcastle does call margin from its derivative counterparties outside of its non-recourse financing
structures. Newcastle’s major derivative counterparties include Bank of America, Deutsche Bank, Wachovia and
Credit Suisse.
Management Fees and Incentive Compensation to Affiliate ⎯ These represent amounts due to the Manager pursuant
to the Management Agreement. For further information on the Management Agreement, see Note 10.
BALANCE SHEET MEASUREMENT
Investment in Real Estate Securities ⎯ Newcastle has classified its investments in securities as available for sale.
Securities available for sale are carried at market value with the net unrealized gains or losses reported as a separate
component of accumulated other comprehensive income, to the extent impairment losses are considered temporary. At
disposition, the net realized gain or loss is determined on the basis of the cost of the specific investments and is
included in earnings. Unrealized losses on securities are charged to earnings if they reflect a decline in value that is
other-than-temporary, as described above.
Investment in Loans ⎯ Loans receivable are presented net of any unamortized discount (or gross of any unamortized
premium), including any fees received, and an allowance for loan losses. Loans which Newcastle does not have the
intent and ability to hold into the foreseeable future are considered held-for-sale and are carried at the lower of
amortized cost or market value.
Investment in Operating Real Estate ⎯ Operating real estate is recorded at cost less accumulated depreciation.
Depreciation is computed on a straight-line basis. Buildings are depreciated over 40 years. Major improvements are
capitalized and depreciated over their estimated useful lives. Fees and costs incurred in the successful negotiation of
leases are deferred and amortized on a straight-line basis over the terms of the respective leases. Expenditures for
repairs and maintenance are expensed as incurred. Newcastle reviews its real estate assets for impairment annually or
whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
Long-lived assets to be disposed of by sale, which meet certain criteria, are reclassified to Real Estate Held for Sale
and measured at the lower of their carrying amount or fair value less costs of sale. The results of operations for such an
asset, assuming such asset qualifies as a “component of an entity” as defined, are retroactively reclassified to Income
(Loss) from Discontinued Operations for all periods presented.
Cash and Cash Equivalents and Restricted Cash ⎯ Newcastle considers all highly liquid short term investments
with maturities of 90 days or less when purchased to be cash equivalents. Substantially all amounts on deposit with
major financial institutions exceed insured limits. Restricted cash consisted of:
Held in CDOs pending reinvestment (Note 8)
Total rate of return swap margin accounts
Bond sinking funds
Trustee accounts
Derivative margin accounts
Restricted property operating accounts
December 31,
2009
2008
$
194,282
-
2,040
3,929
5,073
54
$
27,696
37
-
7,577
8,906
66
$
205,378
$
44,282
Stock Options ⎯ The fair value of the options issued as compensation to the Manager for its successful efforts in
raising capital for Newcastle was recorded as an increase in stockholders’ equity with an offsetting reduction of capital
proceeds received. Options granted to Newcastle’s directors were accounted for using the fair value method.
68
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Preferred Stock ⎯ In March 2003, Newcastle issued 2.5 million shares ($62.5 million face amount) of its 9.75%
Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred”). In October 2005, Newcastle issued 1.6
million shares ($40.0 million face amount) of its 8.05% Series C Cumulative Redeemable Preferred Stock (the “Series
C Preferred”). In March 2007, Newcastle issued 2.0 million shares ($50.0 million face amount) of its 8.375% Series D
Cumulative Redeemable Preferred Stock (the “Series D Preferred”). The Series B Preferred, Series C Preferred and
Series D Preferred are non-voting, have a $25 per share liquidation preference, no maturity date and no mandatory
redemption. Newcastle has the option to redeem the Series B Preferred that began in March 2008, the Series C
Preferred beginning in October 2010, and the Series D Preferred beginning in March 2012, at their face amount. If the
Series C Preferred or Series D Preferred cease to be listed on the NYSE or the AMEX, or quoted on the NASDAQ, and
Newcastle is not subject to the reporting requirements of the Exchange Act, Newcastle has the option to redeem the
Series C Preferred or Series D Preferred, as applicable, at their face amount and, during such time any shares of Series
C Preferred or Series D Preferred are outstanding, the dividend will increase to 9.05% or 9.375% per annum,
respectively.
In connection with the issuance of the Series B Preferred, Series C Preferred and Series D Preferred, Newcastle
incurred approximately $2.4 million, $1.5 million, and $1.8 million of costs, respectively, which were netted against
the proceeds of such offerings. If any series of preferred stock were redeemed, the related costs would be recorded as
an adjustment to income available for common stockholders at that time.
In the fourth quarter of 2008 and in 2009, Newcastle elected not to declare any of the specified dividends on its three
series of preferred stock. As of December 31, 2009, $15.8 million of preferred dividends were in arrears. These
dividends in arrears are included as part of preferred dividends on the consolidated statements of operations, since they
represent a claim on earnings superior to common stockholders, but have not been accrued as Dividends Payable, since
they have not been declared. Moreover, if Newcastle does not pay dividends on any series of preferred stock by April
30, 2010, then holders of each affected series obtain the right to call a special meeting and elect two members to our
board of directors.
Accretion of Discount and Other Amortization ⎯ As reflected on the Consolidated Statements of Cash Flows, this
item is comprised of the following:
Accretion of net discount on securities and loans
$
(58,771)
$
(40,137)
$
(38,048)
2009
2008
2007
Amortization of net discount on debt obligations
Amortization of deferred financing costs and interest rate cap premiums
Amortization of net deferred hedge (gains) and losses - debt
7,004
8,409
9,446
6,157
2,442
(880)
7,394
4,407
(462)
$
(33,912)
$
(32,418)
$
(26,709)
Securitization of Subprime Mortgage Loans ⎯ Newcastle’s accounting policy for its securitization of subprime
mortgage loans is disclosed in Note 5.
Recent Accounting Pronouncements ⎯ In February 2008, the FASB issued new guidance on accounting for a
transfer of a financial asset and a repurchase financing. It presumes that an initial transfer of a financial asset and a
repurchase financing are considered part of the same arrangement (a linked transaction) unless certain criteria are met.
If the criteria are not met, the linked transaction would be recorded as a net investment, likely as a derivative, instead of
recording the purchased financial asset on a gross basis along with a repurchase financing. This guidance applies to
reporting periods beginning after November 15, 2008 and is only applied prospectively to transactions that occur on or
after the adoption date. The adoption of this guidance did not have a material impact on its financial condition,
liquidity or results of operations as Newcastle has not entered into any such transactions since January 2009.
In March 2008, the FASB issued new guidance which applies to reporting periods beginning after November 15, 2008
and requires enhanced disclosures about an entity’s derivative and hedging activities. It does not change the accounting
for such activities. As a result, while the adoption of this guidance has changed Newcastle’s disclosures, it did not have
a material impact on its financial condition, liquidity or results of operations.
In January 2009, the FASB issued new guidance which amends previous guidance to achieve more consistent
determination of whether an other-than-temporary impairment has occurred. In particular, it changed a requirement to
analyze a security’s estimated cash flows from a market participant’s perspective to an analysis from the perspective of
69
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
the holder. It is effective for periods ending after December 15, 2008 and is applied prospectively. Due to the
prospective nature of its adoption, the adoption of this guidance did not have a material impact on its financial
condition, liquidity or results of operations. It did not have a material impact on Newcastle’s impairment analyses
subsequent to adoption because Newcastle generally analyzes cash flows of securities in a manner consistent with
market practice.
In April 2009, the FASB issued new guidance which (i) requires disclosures about the fair value of financial
instruments on an interim basis, (ii) changes the guidance for determining, recording and disclosing other-than-
temporary impairment, and (iii) provides additional guidance for estimating fair value when the volume or level of
activity for an asset or liability have significantly decreased. This guidance was effective for Newcastle as of April 1,
2009. It had a significant impact on Newcastle’s disclosures, but no material impact on its financial condition,
liquidity, or results of operations upon adoption. A reclassification adjustment of $1.3 billion of loss from Accumulated
Deficit to Accumulated Other Comprehensive Income (Loss) was recorded at adoption but had no net effect on equity.
Post-adoption impairment determinations, including the analysis performed at December 31, 2009, are performed using
this new guidance and may result in materially different conclusions than would have been reached under prior
guidance.
In June 2009, the FASB issued new guidance which eliminates the concept of qualified special purpose entities
(QSPEs), changes the requirements for reporting a transfer of a portion of financial assets as a sale, clarifies other sale
accounting criteria and changes the initial measurement of a transferor’s interest in transferred financial assets.
Furthermore, it requires additional disclosures. This guidance is effective for fiscal years beginning after November
15, 2009. Newcastle does not expect that the adoption of this guidance will have a material impact on its financial
position, liquidity or results of operations.
In June 2009, the FASB issued new guidance which changes the definition of a variable interest entity (“VIE”) and
changes the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE.
Furthermore, it eliminates the scope exception for qualified special purpose entities (QSPEs), which are now subject to
the VIE consolidation rules. This guidance is effective for fiscal years beginning after November 15, 2009. Generally,
the changes are expected to cause more entities to be defined as VIE’s and to require consolidation by the entity that
exercises day-to-day control over a VIE, such as servicers and collateral managers. Newcastle expects that the adoption
of this standard will cause Newcastle to deconsolidate one if its CDOs and Newcastle is currently evaluating the
potential impact of this standard on its other financing structures. The results of deconsolidating any of its CDOs or
other non-recourse financing structures would be a reduction to accumulated deficits, to the extent that impairments
taken on assets within a given VIE were in excess of Newcastle’s investment in such VIE, and reductions of the assets
and liabilities of such VIE. These reductions could be material. Newcastle does not expect any other immediate effects
from the adoption of this guidance, but its ongoing consolidation analyses will be altered. To the extent the conclusions
of any future analyses are changed as a result of this guidance, the impact could be material.
70
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
3. SEGMENT REPORTING AND UNCONSOLIDATED SUBSIDIARIES
Newcastle conducts its business through four primary segments: (i) investments financed with non-recourse
collateralized debt obligations (“CDOs”), (ii) investments financed with other non-recourse debt, (iii) investments
financed with recourse debt, including FNMA / FHLMC securities, and (iv) unlevered investments.
The unlevered segment includes the retained equity and bonds from Securitization Trust 2006 and Securitization Trust
2007, as described in Note 5, since our retained interests are not leveraged.
The unallocated portion consists primarily of interest on short term investments, general and administrative expenses,
interest expense on the credit facility (in prior years) and junior subordinated notes payable (Note 8) and management
fees and incentive compensation pursuant to the Management Agreement (Note 10).
Summary financial data on Newcastle’s segments is given below, together with a reconciliation to the same data for
Newcastle as a whole:
Other
Non-Recourse
(A) (B)
CDOs (A)
Recourse
Unlevered
Unallocated
Total
Year Ended December 31, 2009
Interest income
Interest expense
$ 275,938
$ 76,868
$ 7,416
$ 1,543
$ 101
$ 361,866
140,674
65,734
3,763
-
8,239
218,410
Net interest income (expense)
135,264
11,134
3,653
1,543
(8,138) 143,456
Impairment
Other income (loss)
513,234
(24,212) 50,142
9,376
-
548,540
216,128
6,650
4,311
309
1
227,399
Depreciation and amortization
-
-
-
-
290
290
Other operating expenses
Income (loss) from continuing operations
1,619
3,386
(163,461) 38,610
33
31,611
(42,211) (7,744) (34,780) (209,586)
220
26,353
Income (loss) from discontinued operations
-
-
-
(318) -
(318)
Net income (loss)
(163,461) 38,610
(42,211) (8,062) (34,780) (209,904)
Preferred dividends
Income (loss) applicable to common stockholders
December 31, 2009
Investments (C) (E)
Cash and restricted cash
Other assets
Total assets
Debt (E)
Derivative liabilities
Other liabilities
Total liabilities
Preferred stock
GAAP book value (D)
Continued on next page
-
(13,501) (13,501)
$ (163,461) $ 38,610 $ (42,211) $ (8,062) $ (48,281) $ (223,405)
-
-
-
$ 2,389,325
202,461
36,643
2,628,429
$ 732,658
-
-
732,658
$ 72,808
3,056
605
76,469
$ 6,678
461
4
7,143
$ -
67,700
2,229
69,929
$ 3,201,469
273,678
39,481
3,514,628
(103,264) (4,940,204)
(4,058,928) (706,703) (71,309) -
(207,154)
-
(181,913)
-
(7,922)
(165) (4,245)
(2,197)
(5,155,280)
(165) (107,509)
(4,243,038)
(152,500)
(152,500)
-
-
(22,689)
(795)
(730,187)
-
(2,552)
(520)
(74,381)
-
$ (1,614,609) $ 2,471
$ 2,088
$ 6,978
$ (190,080) $ (1,793,152)
71
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Other
Non-Recourse
(A) (B)
CDOs (A)
Recourse
Unlevered
Unallocated
Total
Year Ended December 31, 2008
Interest income
Interest expense
$ 307,891
$ 88,643
$ 47,707
$ 22,672
$ 1,954
$ 468,867
198,980
66,229
33,903
675
7,516
307,303
Net interest income (expense)
108,911
22,414
13,804
21,997
(5,562) 161,564
Impairment
Other income (loss)
Depreciation and amortization
Other operating expenses
2,585,272
105,181
133,316
159,604
-
2,983,373
(37,128) (17,215) (67,296) 9,413
(583) (112,809)
-
-
-
-
289
289
1,563
12,542
40
1,110
25,536
40,791
Income (loss) from continuing operations
(2,515,052) (112,524) (186,848) (129,304) (31,970) (2,975,698)
Income (loss) from discontinued operations
-
-
-
(9,654) -
(9,654)
Net income (loss)
(2,515,052) (112,524) (186,848) (138,958) (31,970) (2,985,352)
Preferred dividends
Income (loss) applicable to common stockholders
December 31, 2008
Investments (C) (E)
Cash and restricted cash
Other assets
Total assets
Debt (E)
Derivative liabilities
Other liabilities
Total liabilities
Preferred stock
GAAP book value (D)
Year Ended December 31, 2007
Interest income
Interest expense
-
(13,501) (13,501)
$ (2,515,052) $ (112,524) $ (186,848) $ (138,958) $ (45,471) $ (2,998,853)
-
-
-
$ 2,168,776
37,483
39,985
2,246,244
$ 751,556
-
-
751,556
$ 284,736
6,733
2,303
293,772
$ 126,699
681
233
127,613
$ 101
49,131
5,206
54,438
$ 3,331,868
94,028
47,727
3,473,623
(100,100) (5,515,199)
(4,359,981) (778,646) (276,472) -
(333,977)
-
(289,406)
-
(17,979)
(777) (5,734)
(1,174)
(5,867,155)
(777) (105,834)
(4,650,561)
(152,500)
(152,500)
-
-
(37,473)
(10,010)
(826,129)
-
(7,098)
(284)
(283,854)
-
$ (2,404,317) $ (74,573) $ 9,918
$ 126,836
$ (203,896) $ (2,546,032)
$ 382,642
$ 98,255
$ 160,605
$ 37,297
$ 1,736
$ 680,535
279,160
72,829
113,595
1,184
10,164
476,932
Net interest income (expense)
103,482
25,426
47,010
36,113
(8,428) 203,603
Impairment
Other income (loss)
Depreciation and amortization
Other operating expenses
138,570
-
57,147
14,210
-
209,927
785
268
(15,697) 5,751
8
(8,885)
-
-
-
-
291
291
1,878
15,903
2,355
20
29,671
49,827
Income (loss) from continuing operations
(36,181) 9,791
(28,189) 27,634
(38,382) (65,327)
Income (loss) from discontinued operations
-
-
-
(130) -
(130)
Net income (loss)
(36,181) 9,791
(28,189) 27,504
(38,382) (65,457)
Preferred dividends
Income (loss) applicable to common stockholders
-
-
$ (36,181) $ 9,791 $ (28,189) $ 27,504
-
-
(12,640) (12,640)
$ (51,022) $ (78,097)
(A) Assets held within CDOs and other non-recourse structures are not available to satisfy obligations outside of such financings, except to the extent
Newcastle receives net cash flow distributions from such structures. Furthermore, economic losses from such structures cannot exceed
Newcastle’s invested equity in them. Therefore, economically their book value cannot be less than zero, except for the amounts described in note
(B) below.
(B) Includes all of the manufactured housing loan financing (Note 8), of which $10.2 million and $50.9 million carrying value was recourse at
December 31, 2009 and 2008, respectively.
(C) At December 31, 2009, carrying values of investments in the unlevered segment include $2.3 million of real estate securities, $4.2 million of real
estate related loans and $0.2 million of interests in a joint venture. A real estate loan of $4.1 million was pledged as collateral for the junior
subordinated notes and will be released at the end of the interest rate modification period. At December 31, 2008, investments in the unlevered
segment included carrying values of $12.3 million of real estate securities, $46.2 million of real estate related loans, $56.1 million of residential
mortgage loans (of which $52.7 million of such loans had been securitized and such securitized interests were held in Newcastle’s CDOs), $11.9
million of operating real estate and $0.3 million of interests in a joint venture. Certain of these investments held at December 31, 2008 were
reclassified to other segments in 2009.
(D) Newcastle cannot economically lose more than its investment amount in any given non-recourse financing structure. Therefore, impairment
recorded in excess of such investment, which results in negative GAAP book value for a given non-recourse financing structure, cannot
economically be incurred and will eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or termination of
such non-recourse financing structure. For non-recourse financing structures with negative GAAP book value, except as noted in (B) above, the
aggregate negative GAAP book value which will eventually be recorded as income is $1.0 billion as of December 31, 2009.
72
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
(E)
Included in the other non-recourse segment were $403.0 million and $398.0 million of Investments and Debt at December 31, 2009 and
December 31, 2008, respectively, representing the loans subject to call option of the two subprime securitizations and the corresponding
financing.
Unconsolidated Subsidiaries
The following table summarizes the activity for significant subsidiaries, excluding the trust preferred subsidiary,
affecting the equity held by Newcastle in unconsolidated subsidiaries. This activity is included in the unlevered
segment.
Balance at December 31, 2007
Distributions from unconsolidated subsidiaries
Equity in earnings of unconsolidated subsidiaries
Balance at December 31, 2008
Distributions from unconsolidated subsidiaries
Equity in earnings of unconsolidated subsidiaries
Balance at December 31, 2009
Operating Real Estate
Real Estate Loan
$ 13,391 $ 10,984
(11,934)
(20,307)
6,916
1,233
$ - $ 283
(509)
-
-
419
$ - $ 193
Summarized financial information related to these unconsolidated subsidiaries was as follows:
Assets
Liabilities
Minority interest
Equity
Operating Real Estate
December 31,
Real Estate Loan
December 31,
2009
$ -
2008
$ -
2007
$ 79,213
2009
$ 388
2008
$ 568
2007
$ 22,093
-
-
(51,929) -
-
-
-
-
(502) (2)
(3) (125)
$ -
$ -
$ 26,782
$ 386
$ 565
$ 21,968
Equity held by Newcastle
$ -
$ -
$ 13,391
$ 193
$ 283
$ 10,984
Revenues
Expenses
Minority interest
Net income
2009
$ -
2008
$ 14,962
2007
$ 8,273
2009
$ 845
2008
$ 2,517
2007
$ 6,755
-
(871) (3,375) (3)
(37) (23)
-
(259) (90) (4)
(14) (38)
$ -
$ 13,832
$ 4,808
$ 838
$ 2,466
$ 6,694
Newcastle's equity in net income
$ -
$ 6,916
$ 2,404
$ 419
$ 1,233
$ 3,347
The unconsolidated subsidiaries’ summary financial information above is presented on a fair value basis, consistent
with their internal basis of accounting as investment companies.
Operating Real Estate Subsidiary
In March 2004 Newcastle purchased a 49% interest in a portfolio of convenience and retail gas stores. Newcastle
structured this transaction through a joint venture in two limited liability companies with a private investment fund
managed by an affiliate of its manager, pursuant to which such affiliate co-invested on equal terms. In April 2008,
Newcastle closed on the sale of its interest in this joint venture and received net proceeds of $19.8 million. As a result,
Newcastle recorded a gain of approximately $6.2 million.
Real Estate Loan Subsidiary
In November 2003, Newcastle and a private investment fund managed by an affiliate of the Manager co-invested and
each indirectly own an approximately 38% interest in DBNC Peach Manager LLC, a limited liability company that has
acquired a pool of franchise loans collateralized by fee and leasehold interests and other assets from a third party
financial institution. The remaining approximately 24% interest in the limited liability company is owned by the
above-referenced third party financial institution. Newcastle has no additional capital commitment to the limited
liability company.
73
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
4. REAL ESTATE SECURITIES
The following is a summary of Newcastle’s real estate securities at December 31, 2009 and 2008, all of which are classified as available for sale and are therefore
reported at fair value with changes in fair value recorded in other comprehensive income, except for securities that are other-than-temporarily impaired.
December 31, 2009
Asset Type
CMBS-Conduit
CMBS- Single Borrower
CMBS-Large Loan
CMBS-CDO
REIT Debt
ABS-Subprime
ABS-Manufactured Housing
ABS-Franchise
FNMA/FHLMC (C)
Subtotal/Average
Retained Securities (E)
Residual Interests (E)
Debt Security Total/Average (D)
Equity Securities
Total
Outstanding
Face Amount
1,733,585
$
620,010
88,556
16,000
518,215
462,503
51,276
34,730
45,494
3,570,369
61,963
23
3,632,355
$
Before
Impairment
1,530,456
$
601,990
90,308
14,731
520,805
431,985
49,795
35,144
47,690
3,322,904
65,709
29,302
3,417,915
1,388
3,419,303
$
Amortized Cost Basis
Other-Than-
Temporary-
Impairment (A)
$
(688,917)
(47,088)
(19,864)
(14,731)
(8,285)
(244,786)
-
(19,345)
-
(1,043,016)
(63,290)
(29,279)
(1,135,585)
Gross Unrealized
Weighted Average
After
Impairment
841,539
$
554,902
70,444
-
512,520
187,199
49,795
15,799
47,690
2,279,888
2,419
23
2,282,330
$
Gains
53,270
4,224
-
-
15,795
8,135
652
188
2,181
84,445
-
-
84,445
$
Losses
(263,340)
(170,288)
(29,132)
-
(41,668)
(24,081)
(5,975)
(3,680)
-
(538,164)
(436)
-
(538,600)
Carrying Value
631,469
$
388,838
41,312
-
486,647
171,253
44,472
12,307
49,871
1,826,169
1,983
23
1,828,175
Number of
Securities
212
69
12
1
59
104
9
17
3
486
6
1
493
Rating (B)
BB+
BB-
B+
C
BB+
B
BBB+
B
AAA
BB
C
NR
BB
Coupon
5.73%
4.20%
1.67%
6.21%
6.12%
1.38%
6.69%
3.78%
5.83%
4.85%
2.21%
0.00%
4.81%
Yield
9.77%
5.70%
2.27%
0.00%
5.97%
13.20%
7.23%
6.75%
5.54%
7.81%
7.46%
25.00%
7.81%
Maturity
(Years)
3.4
2.3
1.2
-
4.2
4.6
5.4
3.0
3.8
3.4
1.8
0.1
3.4
-
(1,135,585)
$
1,388
2,283,718
$
1,478
85,923
$
(246)
(538,846)
$
2,620
1,830,795
$
2
495
December 31, 2008
Asset Type
CMBS-Conduit
CMBS- Single Borrower
CMBS-Large Loan
CMBS-CDO
REIT Debt
ABS-Subprime
ABS-Manufactured Housing
ABS-Franchise
FNMA/FHLMC (C)
Subtotal/Average (D)
Retained Securities (E)
Residual Interests (E)
Total/Average
Outstanding
Face Amount
1,428,461
$
748,347
89,225
16,000
650,666
578,026
61,102
38,654
179,727
3,790,208
80,380
1,155
3,871,743
$
Before
Impairment
1,357,593
$
734,999
89,217
14,730
655,888
520,130
59,903
38,822
181,524
3,652,806
73,587
29,718
3,756,111
$
Amortized Cost Basis
Other-Than-
Temporary-
Impairment (A)
$
(986,790)
(330,049)
(43,410)
(14,730)
(243,304)
(333,387)
(23,913)
(22,994)
-
(1,998,577)
(66,973)
(28,563)
(2,094,113)
$
After
Impairment
370,803
$
404,950
45,807
-
412,584
186,743
35,990
15,828
181,524
1,654,229
6,614
1,155
1,661,998
$
See notes on following page
74
Gross Unrealized
Weighted Average
Gains
$
445
32
-
-
238
3,350
-
-
2,685
6,750
-
-
6,750
$
Losses
-
$
-
-
-
-
-
-
-
-
-
-
-
$ -
Carrying Value
371,248
$
404,982
45,807
-
412,822
190,093
35,990
15,828
184,209
1,660,979
6,614
1,155
1,668,748
$
Number of
Securities
179
70
12
1
65
123
9
17
6
482
7
1
490
Rating (B)
BBB
BB+
BB+
CC
BB+
BB
BBB
BBB-
AAA
BBB-
CCC-
NR
BBB-
Yield
Coupon
38.91%
5.74%
5.26%
26.97%
2.78% 116.96%
10.14%
6.25%
1.78%
6.68%
4.26%
5.34%
5.06%
2.55%
0.00%
5.01%
0.00%
18.15%
28.35%
13.14%
35.97%
5.39%
27.54%
20.00%
30.00%
27.51%
Maturity
(Years)
6.3
3.3
1.4
-
4.7
5.2
5.1
5.5
2.8
4.9
2.6
0.7
4.9
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
(A) Represents the cumulative impairment against amortized cost basis through earnings, net of the effect of the cumulative adjustment as a result
of the adoption of new accounting guidance on impairment in 2009.
(B) Represents the weighted average of the ratings of all securities in each asset type, expressed as an S&P equivalent rating. For each security
rated by multiple rating agencies, the lowest rating is used. FNMA/FHLMC securities have an implied AAA rating. Ratings provided were
determined by third party rating agencies as of a particular date, may not be current and are subject to change (including the assignment of a
“negative watch” at any time).
(C) Amortized cost basis and carrying value include principal receivable of $1.7 million and $2.0 million, as of December 31, 2009 and 2008,
respectively.
(D) As of December 31, 2009 and 2008, the total outstanding face amount of fixed rate securities was $2.7 billion and $2.8 billion, respectively, and
of floating rate securities was $971.6 million and $1.1 billion, respectively.
(E) Represents the retained bonds and equity from Securitization Trust 2006 and Securitization Trust 2007 as described in Note 5. The residuals do
not have stated coupons and therefore their coupons have been treated as zero for purposes of the table.
Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the years
ended December 31, 2009, 2008 and 2007, Newcastle recorded other-than-temporary impairment charges (“OTTI”) of
$603.8 million, $2.0 billion and $202.6 million, respectively, with respect to real estate securities (gross of $70.2
million of other-than-temporary impartment recognized in Other Comprehensive Income in 2009). Based on
management’s analysis of these securities, the performance of the underlying loans and changes in market factors,
Newcastle noted adverse changes in the expected cash flows on certain of these securities and concluded that they were
other-than-temporarily impaired. Any remaining unrealized losses as of each balance sheet date on Newcastle’s
securities were primarily the result of changes in market factors, rather than issuer-specific credit impairment.
Newcastle performed analyses in relation to such securities, using management’s best estimate of their cash flows,
which support its belief that the carrying values of such securities were fully recoverable over their expected holding
period. Such market factors include changes in market interest rates and credit spreads, or certain macroeconomic
events, including market disruptions and supply changes, which did not directly impact our ability to collect amounts
contractually due. Management continually evaluates the credit status of each of Newcastle’s securities and the
collateral supporting those securities. This evaluation includes a review of the credit of the issuer of the security (if
applicable), the credit rating of the security, the key terms of the security (including credit support), debt service
coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the
collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. These
factors include loan default expectations and loss severities, which are analyzed in connection with a particular
security’s credit support, as well as prepayment rates. The result of this evaluation is considered when determining
management’s estimate of cash flows and in relation to the amount of the unrealized loss and the period elapsed since it
was incurred. Significant judgment is required in this analysis. The following table summarizes Newcastle’s securities
in an unrealized loss position as of December 31, 2009.
Securities in
an Unrealized
Loss Position
Less Than
Twelve Months
Twelve or
More Months
Total
Outstanding
Face
Amount
Amortized Cost Basis
Other-than-
Temporary
Impairment
After
Impairment
Before
Impairment
Gross Unrealized
Weighted Average
Gains
Losses
Carrying
Value
Number
of
Securities
Rating
Coupon Yield
Maturity
(Years)
$
86,853
$
87,609
$
(57,784)
$
29,825
$
-
$
(2,004)
27,821
27
B
2.92% 12.06%
2,024,751
2,111,604
$
1,975,829
2,063,438
$
(375,327)
(433,111)
$
1,600,502
1,630,327
$
-
-
$
(536,842)
(538,846)
$
1,063,660
1,091,481
$
290
317
BB
BB
4.74% 5.51%
4.66% 5.63%
2.2
3.7
3.7
In April 2009, the FASB issued new guidance which changes the guidance for determining, recording and disclosing
OTTI. This guidance applies to debt securities in an unrealized loss position (i.e. their fair value is less than their
amortized cost basis) as follows:
Old Guidance
Current Guidance
Must express an intent and ability to hold securities
until an expected recovery in value to amortized cost
basis, or else record OTTI for the difference between
fair value and amortized cost.
Must not have the intent to sell a security nor be in a
position where a required sale is more likely than not,
or else record OTTI for the difference between fair
value and amortized cost.
If no recovery to amortized cost basis is expected, must
record OTTI in the same amount.
Otherwise, must record OTTI relating to the portion of
the unrealized loss which represents a credit loss, if
any.
75
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Newcastle performed an assessment of all of its debt securities that are in an unrealized loss position (unrealized loss
position exists when a security’s amortized cost basis, excluding the effect of OTTI, exceeds its fair value) in
accordance with this guidance and determined the following:
Securities Newcastle intends to sell
Securities Newcastle is more likely than not to be required to sell (A)
Securities Newcastle has no intent to sell and is not more likely
than not to be required to sell:
Credit impaired securities
Non credit impaired securities
Total debt securities in an unrealized loss position
December 31, 2009
Amortized
Unrealized Losses
Fair Value
-
$
-
Cost Basis
-
$
-
Credit (B)
-
$
-
Non-Credit (C)
N/A
N/A
123,422
968,029
1,091,451
195,645
1,434,406
1,630,051
(433,110)
-
(433,110)
(72,222)
(466,378)
(538,600)
(A) Newcastle may, at times, be more likely than not to be required to sell certain securities for liquidity purposes. While the amount of the
securities to be sold may be an estimate, and the securities to be sold have not yet been identified, this guidance requires Newcastle to make its
best estimate, which is subject to significant judgment regarding future events, and may differ materially from actual future sales.
(B) Excluding the effect of previously recorded OTTI, which must be reconsidered as a result of this guidance. This amount is required to be
recorded as other-than-temporary impairment through earnings. Of this amount, $192.9 million relates to prior periods (and was recorded as
part of the reclassification adjustment upon adoption, as described below) and $240.2 million relates to the year ended December 31, 2009. In
measuring the portion of credit losses, Newcastle’s management estimates the expected cash flow for each of the securities. This evaluation
includes a review of the credit status and the performance of the collateral supporting those securities, including the credit of the issuer, key
terms of the securities and the effect of local, industry and broader economic trends. Significant inputs in estimating the cash flows include
management’s expectations of prepayment speeds, default rates and loss severities. Credit losses are measured as the decline in the present
value of the expected future cash flows discounted at the investment’s effective interest rate.
(C) This amount represents unrealized losses on securities that are due to non-credit factors and is required to be recorded through other
comprehensive income.
As a result of this reassessment, Newcastle has recorded a reclassification adjustment upon adoption of this guidance of
$1.3 billion of loss from Accumulated Deficit to Accumulated Other Comprehensive Income (Loss). The reclassification
adjustment had no impact on total consolidated assets, liabilities or equity and did not impact Newcastle’s liquidity. This
represents a substantive reversal of a large portion of the impairment charge recorded in the fourth quarter of 2008,
which was originally recorded as a result of Newcastle’s inability to express the intent and ability to hold its securities
until an expected recovery in value (if any).
The following table summarizes the activity related to credit losses on debt securities for the period from adoption of
this guidance through December 31, 2009:
Beginning balance of credit losses on debt securities for which a portion of an OTTI was recognized
in other comprehensive income
$
(363,125)
Additions for credit losses on securities for which an OTTI was not previously recognized
Increases to credit losses on securities for which an OTTI was previously recognized and a
portion of an OTTI was recognized in other comprehensive income
Additions for credit losses on securities for which an OTTI was previously recognized without
any portion of OTTI recognized in other comprehensive income
Reduction for credit losses on securities for which no OTTI was recognized in other comprehensive
income at December 31, 2009
Reduction for securities sold during the period
Reduction for increases in cash flows expected to be collected that are recognized over the remaining
life of the security
Ending balance of credit losses on debt securities for which a portion of an OTTI was recognized in
other comprehensive income
(157,783)
(99,589)
(84,855)
268,468
3,774
24,328
$
(408,782)
The securities are encumbered by the CDO bonds payable and certain repurchase agreements (Note 8) at December 31,
2009.
As of December 31, 2009 and 2008, Newcastle had $194.3 million and $27.7 million of restricted cash, respectively,
held in CDO financing structures pending its reinvestment in real estate securities and loans.
76
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
The table below summarizes the geographic distribution of the collateral securing our CMBS at December 31, 2009:
Geographic Location
Outstanding Face Amount
Percentage
Northeastern U.S.
Western U.S.
Southeastern U.S.
Midwestern U.S.
Southwestern U.S.
Other
Foreign
$
614,458
581,640
478,728
324,415
267,472
169,440
21,998
2,458,151
25.0%
23.7%
19.5%
13.2%
10.9%
6.9%
0.9%
100.0%
$
Geographic concentrations of investments expose Newcastle to the risk of economic downturns within the relevant
regions, particularly given the current unfavorable market conditions. These market conditions may make regions more
vulnerable to downturns in certain market factors. Any such downturn in a region where Newcastle holds significant
investments could have a material, negative impact on Newcastle.
77
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 and 2007
(dollars in tables in thousands, except per share data)
5. REAL ESTATE RELATED LOANS, RESIDENTIAL MORTGAGE LOANS AND SUBPRIME MORTGAGE
LOANS
All of Newcastle’s loan investments were classified as held for sale as of December 31, 2009 and 2008 and marked to
the lower of carrying value or fair value.
The following is a summary of real estate related loans, residential mortgage loans and subprime mortgage loans. The
loans contain various terms, including fixed and floating rates, self-amortizing and interest only. They are generally
subject to prepayment.
December 31, 2009
December 31, 2008
Loan Type
Mezzanine Loans
Corporate Bank Loans
B-Notes
Whole Loans
Total Real Estate Related
Loans Held for Sale, net (D)
Residential Loans
Manufactured Housing
Loans
Total Residential
Mortgage Loans Held for
Sale, Net (E)
Subprime Mortgage Loans
subject to Call Option
Outstanding
Face Amount
718,298
$
314,134
308,082
93,305
Carrying
Value (A)
240,185
$
198,828
79,427
55,422
Loan
Count
21
10
11
4
Wtd. Avg.
Yield
43.64%
7.08%
36.48%
24.01%
Wtd. Avg.
Coupon
4.77%
5.93%
4.43%
2.33%
$
1,433,819
$
573,862
46
32.81%
4.79%
$
69,930
$
53,995
241
5.25%
2.80%
414,233
329,652
12,372
11.23%
9.37%
$
484,163
$
383,647
12,613
10.37%
8.42%
Weighted
Average
Maturity
(Years) (B)
1.9
3.4
1.9
1.6
Floating Rate
Loans as a
Percentage of
Face Amount
85.7%
100.0%
84.2%
97.6%
$
Delinquent
Face Amount
(C)
49,404
121,504
131,589
-
$
Carrying
Value
395,443
216,356
154,159
77,254
Wtd. Avg.
Yield
32.59%
47.86%
25.84%
20.39%
2.2
5.6
6.6
6.5
89.3%
$
302,497
$
843,212
34.16%
100.0%
$
7,220
$
56,102
10.13%
10.7%
6,784
353,530
15.56%
23.6%
$
14,004
$
409,632
14.82%
$
406,217
$
403,006
$
398,026
(A) The aggregate United States federal income tax basis for such assets at December 31, 2009 was approximately $1.6 billion, excluding the
securitized subprime mortgage loans which are fully consolidated for tax purposes.
(B) The weighted average maturities were calculated based on constant voluntary prepayment rates (CPR) of approximately 30% and 7% for the
two residential loan pools, and 4% and 6% for the two manufactured housing loan pools.
(C) Includes loans that are non-performing, in foreclosure, under bankruptcy filing or considered real estate owned. $194.6 million face amount of
these loans was placed on non-accrual status as of December 31, 2009.
(D) Loans which are more than 3% of the total current carrying value (or $17.2 million) at December 31, 2009 are as follows:
Loan Type
Individual Bank Loan
Individual Mezzanine Loan
Individual Bank Loan
Individual Mezzanine Loan
Individual Mezzanine Loan
Individual Mezzanine Loan
Individual Whole Loan
Individual Whole Loan
Individual Bank Loan
Individual Bank Loan
Individual Mezzanine Loan
Individual B-Note
Others
(3)
(2)
(2)
(2)
(2)
(2)
(2)
(4)
(2)
(3)
(2)
(5)
(6)
December 31, 2009
Outstanding
Face Amount Carrying Value
Loan
Count
Yield (1)
Coupon (1)
Weighted Average
Maturity
(Years)
$
71,449
$
64,363
87,664
92,000
51,615
53,510
39,300
53,949
37,129
27,000
48,857
38,510
25,000
43,832
35,190
30,969
28,895
27,903
27,190
25,990
25,110
21,375
20,795
19,000
807,836
203,250
$
1,433,819
$
573,862
1
1
1
1
1
1
1
1
1
1
1
1
34
46
7.46%
68.02%
0.00%
25.92%
53.92%
24.81%
28.19%
21.04%
10.09%
0.00%
57.20%
12.18%
32.55%
28.09%
11.75%
2.73%
2.24%
3.17%
3.48%
1.92%
2.34%
2.00%
9.75%
5.00%
5.21%
6.43%
5.06%
4.79%
5.00
1.33
3.99
2.58
1.50
1.67
1.23
2.08
2.58
1.60
1.50
6.42
1.95
2.24
1) Weighted average yield and weighted average coupon for Others.
2)
3) Defaulted.
Interest only payments over life to maturity and balloon principal payment upon maturity.
78
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
4)
Interest only payments over life to maturity with a scheduled principal paydown of $2.0 million in March 2010 and the remaining
outstanding principal payment upon maturity.
5) Monthly interest only payments through June 2010 and scheduled monthly principal amortization and interest payments
beginning June 2010. Final extended maturity of this loan is May 2016.
6) Various terms of payment.
(E) Carrying value includes interest receivable of $0.2 million for the residential loans and principal and interest receivable of $8.1 million for the
manufactured housing loans as of December 31, 2009.
Activities relating to the carrying value of our real estate loans and residential mortgage loans are as follows:
December 31, 2007
Purchases / Additional fundings
Principal paydowns
Sales
Provision for credit losses
Provision for losses, loans held for sale
Provision for impaired loans
Gain on disposition of loans held for sale
Loss on disposition of loans held for sale
Accretion of loan discount and other amortization
Other
December 31, 2008
Additional fundings
Principal paydowns (A)
Sales
Valuation (allowance) reversal on loans
Other
December 31, 2009
$
$
Real Estate Related Loans
1,856,978
154,459
(171,870)
(119,115)
(200)
(506,231)
(351,902)
1,434
(41,924)
21,840
(257)
843,212
10,777
(207,299)
(28,781)
(44,564)
517
573,862
Residential Mortgage Loans
634,605
-
(90,831)
-
(8,257)
(126,322)
(1,222)
-
-
2,845
(1,186)
409,632
-
(54,177)
-
29,557
(1,365)
383,647
$
$
(A) Includes $1.4 million carrying value of two bank loans converted to equity securities during the year ended December 31, 2009.
The following is a reconciliation of the loss allowance:
Balance at December 31, 2007
Provision for credit losses
Provision for losses, loans held for sale
Provision for impaired loans
Realized losses
Balance at December 31, 2008
Charge-offs (A)
Valuation (allowance) reversal on loans
Real Estate Related Loans
Residential Mortgage Loans
$
(600)
$
(6,917)
(200)
(506,231)
(351,902)
31,605
(827,328)
49,483
(44,564)
(8,257)
(126,322)
(1,222)
6,512
(136,206)
10,240
29,557
Balance at December 31, 2009
$
(822,409)
$
(96,409)
(A) The charge-offs for real estate related loans represent six bank loans and one B-notes which were sold or converted to equity securities
during the period.
The average carrying amount of Newcastle’s real estate related loans was approximately $668.4 million, $1.7 billion
and $2.0 billion during 2009, 2008 and 2007, respectively, on which Newcastle earned approximately $53.8 million,
$124.4 million and $176.4 million of gross interest revenues, respectively.
The average carrying amount of Newcastle’s residential mortgage loans was approximately $380.2 million, $570.0
million and $701.2 million during 2009, 2008 and 2007, respectively, on which Newcastle earned approximately $42.6
million, $56.0 million and $95.9 million of gross interest revenues, respectively.
The loans are encumbered by various debt obligations as described in Note 8.
Real estate owned (“REO”) as a result of foreclosure on loans is included in Receivables and Other Assets, and is
recorded at the lower of cost or fair value. No material REO was owned as of December 31, 2009 or 2008.
79
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Securitization of Subprime Mortgage Loans
Newcastle acquired and securitized two portfolios of subprime residential mortgage loans (“Subprime Portfolio I” and
“Subprime Portfolio II”), through subsidiaries, as summarized in the table below. Both portfolios are being serviced by
an affiliate of the Manager for a servicing fee equal to 0.50% per annum on their respective unpaid principal balances.
Both portfolios were financed with repurchase agreements prior to their securitization. Newcastle entered into interest
rate swaps in order to hedge its exposure to the risk of changes in market interest rates with respect to these repurchase
agreements. The repurchase agreements were each repaid from proceeds of the respective securitizations. The interest
rate swaps both resulted in gains being recorded to Other Income prior to securitization.
Both portfolios were considered “held for sale” prior to their securitization and therefore were carried at the lower of
cost or fair value, which resulted in a write down in both cases being recorded to Provision for Losses, Loans Held for
Sale. Furthermore, the acquisition of loans held for sale is considered an operating activity for statement of cash
purposes. An offsetting cash inflow from the sale of such loans was recorded as an operating cash flow upon
securitization.
Both portfolios were securitized through qualified special purpose entities (“Securitization Trust 2006” and
(“Securitization Trust 2007”) which are not consolidated by Newcastle. Newcastle retained a portion of the notes
issued by, and all of the equity of, both entities. Newcastle, as holder of the equity (or residual interest), has the option
(a call option) to redeem the notes once the aggregate principal balance of Subprime Portfolio I or Subprime Portfolio
II is equal to or less than 20% or 10%, respectively, of such balance at the date of the transfer. The transactions
between Newcastle and each securitization trust qualified as sales for accounting purposes. However, the loans which
are subject to a call option by Newcastle were not treated as being sold and are classified as “held for investment”
subsequent to the completion of the securitizations. The loans subject to call option and the corresponding financing
recognize interest income and expense based on the expected weighted average coupons of the loans subject to call
option at the call date of 9.24% and 8.68% for Subprime Portfolios I and II, respectively. The call options are “out of
the money,” meaning that the price Newcastle would have to pay to acquire such loans exceeds their fair value at this
time, and there is no requirement to exercise such options.
In both transactions, the residual interests and the retained bonds are reported as real estate securities, available for
sale. The retained loans subject to call option and corresponding financing are reported as separate line items on
Newcastle’s balance sheet.
Newcastle has no obligation to repurchase any loans from either of its subprime securitizations. Therefore, it is
expected that its exposure to loss is limited to the carrying amount of its retained interests in the securitization entities,
as described above. A subsidiary of Newcastle gave limited representations and warranties with respect to Subprime
Portfolio II; however, it has no assets and does not have recourse to the general credit of Newcastle.
Subprime Portfolio
Date of acquisition
Original number of loans (approximate)
Predominant origination date of loans
Original face amount of purchase
Pre-securitization loan write-down
Gain on pre-securitization hedge
Gain on sale
Securitization date
Face amount of loans at securitization
Face amount of notes sold by trust
Stated maturity of notes
Face amount of notes retained by Newcastle
Fair value of equity retained by Newcastle
Key assumptions in measuring such fair value (A):
Weighted average life (years)
Expected credit losses
Weighted average constant prepayment rate
Discount rate
(A) As of the date of transfer.
I
March 2006
11,300
2005
$1.5 billion
($4.1 million)
$5.5 million
Less than $0.1 million
April 2006
$1.5 billion
$1.4 billion
March 2036
$37.6 million
$62.4 million (A)
3.1
5.3%
28.0%
18.8%
80
II
March 2007
7,300
2006
$1.3 billion
($5.8 million)
$5.8 million
$0.1 million
July 2007
$1.1 billion
$1.0 billion
April 2037
$38.8 million
$46.7 million (A)
3.8
8.0%
30.1%
22.5%
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
The following table presents information on the retained interests in securitizations of Subprime Portfolios I and II,
which includes the residual interests and the retained notes described above, and the sensitivity of their fair value to
call date for immediate 10% and 20% adverse changes in the assumptions utilized in calculating such fair value, at
December 31, 2009:
Subprime Portfolio
I
II
Total securitized loans (unpaid principal balance) (A)
$
587,426
$
785,003
Loans subject to call option (carrying value)
$
299,176
$
103,830
Retained interests (fair value) (B)
$
1,511
$
495
Weighted average life (years) of residual interest
Weighted average yield of retained notes
Weighted average expected credit losses (C)
-
6.0%
24.0%
0.1
15.0%
47.1%
Effect on fair value of retained interests of 10% adverse change
$
(184)
$
(76)
Effect on fair value of retained interests of 20% adverse change
$
(439)
$
(132)
Weighted average constant prepayment rate (D)
10.2%
4.0%
Effect on fair value of retained interests of 10% adverse change
$
(10)
$
(10)
Effect on fair value of retained interests of 20% adverse change
$
(18)
$
(23)
Weighted average discount rate
15.0%
27.4%
Effect on fair value of retained interests of 10% adverse change
$
(160)
$
(4)
Effect on fair value of retained interests of 20% adverse change
$
(291)
$
(8)
(A) Average loan seasoning of 53 months and 35 months for Subprime Portfolios I and II, respectively, at December 31, 2009.
(B) The retained interests include residual interests and retained bonds of the securitizations. Their fair value is estimated based on pricing models.
(C) Represents the percentage of losses on the original principal balance of the loans from the date of securitization to the maturity of the loans.
(D) Represents the weighted average voluntary prepayment rate for the loans from the date of securitization to the maturity of the loans.
The sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by
stressing a particular economic assumption independent of changes in any other assumption; in practice, changes in
one factor may result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the
fair value based on a 10% or 20% variation in an assumption generally may not be extrapolated because the
relationship of the change in the assumption to the change in fair value may not be linear.
81
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
The following table summarizes certain characteristics of the underlying loan, and related financing, in the
securitizations as of December 31, 2009:
Subprime Portfolio
I
II
Loan unpaid principal balance (UPB)
Weighted average coupon rate of loans
Delinquencies of 60 or more days (UPB) (A)
Net credit losses for year ended
December 31, 2009
December 31, 2008
Cumulative net credit losses
Cumulative net credit losses as a % of original UPB
Percentage of ARM loans (B)
Percentage of loans with loan-to-value ratio >90%
Percentage of interest-only loans
Face amount of debt (C)
Weighted average funding cost of debt (D)
$
$
$
$
$
$
$
$
$
$
587,426
7.01%
170,807
80,684
41,273
125,528
8.36%
53.8%
10.5%
23.5%
564,288
1.73%
$
$
785,003
6.84%
289,888
83,283
19,964
103,247
9.49%
66.7%
17.2%
4.1%
738,274
2.34%
(A) Delinquencies include loans 60 or more days past due, in foreclosure, under bankruptcy filing or real estate owned.
(B) ARM loans are adjustable-rate mortgage loans. An option ARM is an adjustable-rate mortgage that provides the borrower with an option to
choose from several payment amounts each month for a specified period of the loan term. None of the loans in the subprime portfolios are an
option ARM.
(C) Excludes face amount of $23.1 million and $38.8 million of retained notes for Subprime Portfolios I and II, respectively, at December 31,
2009.
(D) Includes the effect of applicable hedges.
Cash flows related to the two securitizations were as follows:
Year Ended December 31, 2009
Net cash inflows from retained interests
Year Ended December 31, 2008
Net cash inflows from retained interests
Year Ended December 31, 2007
Proceeds from securitization
Net cash inflows from retained interests
Suprime Portfolio
I
II
$
878
$
1,461
$
6,010
$
12,684
$
N/A
23,670
$
$
969,747
15,293
82
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
6. OPERATING REAL ESTATE, HELD FOR SALE
Newcastle has committed to a plan, and is actively working, to sell all of its operating real estate. As a result, all of the
real estate has been classified as held for sale at December 31, 2009 and 2008 and marked to the lower of cost or
market value based on a discounted cash flow analysis, resulting in a recorded loss of $0.3 million and $9.7 million for
the years ended December 31, 2009 and December 31, 2008, respectively. All of the related operations, including these
losses, have been classified as discontinued operations for all periods presented.
The following table summarizes the financial information for the discontinued operations:
Interest income
Rental income
Expenses
Impairment
Net gain on sale
Other income
Net income (loss)
2007
$
Year Ended December 31,
2008
6
$
4,995
5,001
4,632
369
(10,049)
18
8
(9,654)
2009
-
$
2,106
2,106
1,916
190
(550)
-
42
(318)
$
$
$
33
6,673
6,706
6,968
(262)
-
118
14
(130)
No income tax related to discontinued operations was recorded for the years ended December 31, 2009, 2008 or 2007.
The following table sets forth certain information regarding the operating real estate portfolio:
Type of Property
Location
Net
Rentable
Sq. Ft. (A)
Acquisition
Date
Year Built/
Renovated
(A)
Ohio Portfolio
Office Building
Office Building
Office Building
Retail
Office Building
(A) Unaudited.
Beavercreek, OH
Beavercreek, OH
Beavercreek, OH
Dayton, OH
Vandalia, OH
56,659
29,916
45,500
33,485
46,614
212,174
Mar 06
Mar 06
Mar 06
Mar 06
Mar 06
1986
1986
1986
1989
1987
Costs Capitalized
Subsequent to
Acquisition
Occupancy (A)
$
390
132
383
29
165
76.0%
100.0%
100.0%
81.0%
55.0%
Initial Cost
$
2,673
2,727
2,624
1,423
1,592
$
11,039
$
1,099
81.0%
The following is a schedule of the future minimum rental payments to be received under non-cancelable operating
leases:
2010
2011
2012
2013
2014
Thereafter
$
2,088
1,865
1,237
877
865
-
$
6,932
The aggregate United States federal income tax basis for Newcastle’s operating real estate at December 31, 2009 was
approximately $10.4 million. The operating real estate portfolio was pledged as collateral for one of the recourse
financing agreements at December 31, 2009.
83
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value may be based upon broker quotations, counterparty quotations or pricing services quotations, which provide valuation estimates based upon reasonable market
order indications or a good faith estimate thereof and are subject to significant variability based on market conditions, such as interest rates, credit spreads and market
liquidity. A significant portion of Newcastle’s loans, securities and debt obligations are currently not traded in active markets and therefore have little or no price
transparency. As a result, Newcastle has estimated the fair value of these illiquid instruments based on internal pricing models rather than quotations. The determination
of estimated cash flows used in pricing models is inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or
methodology used to determine fair value, could result in a significant change to estimated fair values. It should be noted that minor changes in assumptions or estimation
methodologies can have a material effect on these derived or estimated fair values, and that the fair values reflected below are indicative of the interest rate and credit
spread environments as of December 31, 2009 and do not take into consideration the effects of subsequent changes in market or other factors.
Fair Value Summary Table
The carrying values and estimated fair values of Newcastle's financial instruments at December 31, 2009 and 2008 were as follows:
December 31, 2009
December 31, 2008
Principal
Balance or
Notional
Amount
Carrying Value
Estimated Fair
Value
Fair Value Method (A)
Weighted
Average
Yield/Funding
Cost
Weighted
Average
Maturity
(Years)
Assets:
Real estate securities, available for sale*
$
3,632,355
$
1,830,795
$
1,830,795
Real estate related loans held for sale
1,433,819
573,862
573,862
484,163
383,647
383,647
Broker quotations, counterparty quotations,
pricing services, pricing models
Broker quotations, counterparty quotations,
pricing services, pricing models
Pricing models
7.81%
28.09%
10.39%
Residential mortgage loans held for sale
Subprime mortgage loans subject to
call option (B)
Liabilities:
CDO bonds payable
Other bonds payable
Repurchase agreements
Financing of subprime mortgage loans
subject to call option (B)
Junior subordinated notes payable
Interest rate swaps, treated as hedges (C)(E)*
Non-hedge derivatives (D)(E)*
*Measured at fair value on a recurring basis.
406,217
403,006
403,006
(B)
4,067,296
304,400
71,309
406,217
102,500
2,099,435
296,243
4,058,928
303,697
71,309
1,346,406
251,397
71,309
Counterparty quotations, pricing models
Pricing models
Market comparables
403,006
103,264
178,037
29,117
403,006
33,005
178,037
29,117
(B)
Pricing models
Counterparty quotations
Counterparty quotations
9.09%
3.20%
6.03%
3.83%
9.09%
7.28%
N/A
N/A
Carrying Value
Estimated Fair
Value
$
1,668,748
$
1,668,748
843,212
843,362
409,632
409,632
398,026
398,026
4,359,981
380,620
276,472
1,008,360
333,428
276,472
398,026
100,100
317,757
16,220
398,026
25,025
317,757
16,220
3.4
2.2
6.5
(B)
4.3
0.9
0.2
(B)
26.1
(C)
(D)
(A) Methods are listed in order of priority. In the case of real estate securities and real estate related loans, broker quotations are obtained if available and practicable, otherwise counterparty quotations or pricing
service valuations are obtained or, finally, internal pricing models are used. Internal pricing models are only used for (i) securities and loans which are not traded in an active market, and therefore have little
or no price transparency, and for which significant unobservable inputs must be used in estimating fair value, or (ii) loans or debt obligations which are private and untraded.
(B) These two items results from an option, not an obligation, to repurchase loans from Newcastle’s subprime mortgage loan securitizations (Note 5), are noneconomic until such option is exercised, and are
equal and offsetting.
84
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
(C) Represents current swap agreements as follows:
Year of Maturity
Weighted Average
Month of Maturity
Aggregate Notional
Amount
Weighted Average
Fixed Pay Rate
Aggregate Fair Value
Liability, Net
Agreements which receive 1-Month LIBOR:
2011
2012
2014
2015
2016
2017
Dec
Jul
Oct
Sep
May
Aug
$
109,436
19,027
7,400
1,262,644
180,155
135,034
Agreements which receive 3-Month LIBOR:
2011
2014
Feb
Jun
32,000
353,739
2,099,435
$
5.00%
5.39%
5.12%
5.24%
5.04%
5.13%
5.08%
4.20%
$
(7,580)
(1,469)
(693)
(112,516)
(18,015)
(14,726)
(1,577)
(21,461)
(178,037)
$
(D) These include three interest rate swaps relating to the manufactured housing loans with a total notional balance of $248.2 million and five
interest rate swaps with a total notional balance of $48.0 million relating to certain CDO financing. The maturity dates of the $93.7 million,
$3.3 million, and $151.2 million interest rate swaps for the manufactured housing loans are January 2016, January 2016, and June 2016,
respectively. The five interest rate swaps relating to certain CDO financing were subsequently re-designated as cash flow hedges in January
2010. The maturity dates of the $20.0 million, $19.0 million and $9.0 million re-designated interest rate swaps are July 2019, June 2017 and
November 2010, respectively.
(E) Newcastle’s derivatives fall into two categories. Derivatives held within Newcastle’s nonrecourse debt structures (primarily CDOs) with an
aggregate notional balance of $2.3 billion, all of which were liabilities at period end, are not subject to Newcastle’s credit risk as they are senior
to all the debt obligations of the related CDO. Derivatives held outside Newcastle’s CDOs with an aggregate notional balance of $68.7 million
are primarily 100% collateralized by margin (based on their current fair value) and therefore are not subject to Newcastle’s or its counterparty’s
credit risk. As a result, no adjustments have been made to the fair value quotations received related to credit risk. Newcastle’s significant
derivative counterparties include Bank of America, Deutsche Bank, Wachovia and Credit Suisse.
Securities Valuation
As of December 31, 2009, Newcastle’s securities valuation methodology and results are further detailed as follows:
Asset Type
CMBS
ABS - subprime
Subprime retained
Subprime residuals
ABS - other real estate
FNMA / FHLMC
REIT debt
Outstanding
Face
Amount (A)
Amortized
Cost
Basis (B)
Multiple
Quotes (C)
Fair Value
Single
Quote (D)
$
2,458,151
462,503
61,963
23
86,006
45,494
518,215
$
1,466,885
187,199
2,419
23
65,594
47,690
512,520
$
762,318
67,617
-
-
20,145
-
447,383
$
171,181
20,265
-
-
25,915
49,871
39,264
Internal
Pricing
Models (E)
$
128,120
83,371
1,983
23
10,719
-
-
Total
$
1,061,619
171,253
1,983
23
56,779
49,871
486,647
Debt Security Total
$
3,632,355
2,282,330
1,297,463
306,496
224,216
1,828,175
Equity Securities
Total
(A) Net of incurred losses.
1,388
2,283,718
$
-
1,297,463
$
-
306,496
$
2,620
226,836
$
2,620
1,830,795
$
(B) Net of discounts (or gross premiums) and after OTTI, including impairment taken during the period ended December 31, 2009.
(C) Management generally obtained quotations from multiple sources, when available, including seller (the party that sold us the security)
quotations, other broker quotations and pricing service quotations. Management selected one of the quotes received as being most
representative of fair value and did not use an average of the quotes. Newcastle’s methodology is to not use quotes from selling brokers, unless
those quotes are the only marks available, or unless the quotes provided by other (non-selling) brokers or pricing services are, in management’s
judgment, not representative of fair value. Even if Newcastle receives two or more quotes on a particular security that come from non-selling
brokers or pricing services, it does not use an average because management believes using an actual quote more closely represents a
transactable price for the security than an average level. Furthermore, in some cases there is a wide disparity between the quotes Newcastle
receives. Management believes using an average of the quotes in these cases would generally not represent the fair value of the asset. Based on
Newcastle’s own fair value analysis using internal models, management selects one of the quotes which is believed to more accurately reflect
fair value. Newcastle never adjusts quotes received.
(D) Management was unable to obtain quotations from more than one source on these securities. The one source was generally the seller (the party
that sold us the security) or a pricing service.
85
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
(E) Securities whose fair value was estimated based on internal pricing models are further detailed as follows:
Asset Type
CMBS - conduit
CMBS - Large loan
/ single borrower
ABS - subprime
Subprime retained
Subprime residuals
ABS - other real estate
Debt security total
Equity securities
Amortized
Cost
Basis (B)
Fair
Value
Impairment
Recorded in
Current Year
Unrealized
Gains (Losses)
in Accum. OCI
Assumption Ranges
Discount
Rate
Prepayment
Speed (F)
Cumulative
Default Rate
Loss
Severity
$
129,190
$
95,376
$
273,263
$
(33,814)
20%
N/A
3% - 35%
0% - 29%
69,548
101,738
2,418
23
12,643
315,560
1,388
32,744
83,371
1,983
23
10,719
224,216
2,620
65,288
72,861
3,386
716
4,691
420,205
-
(36,804)
(18,367)
(435)
-
(1,924)
(91,344)
1,232
20% - 88%
15%
15%
25%
15%
N/A
0% - 100%
0% - 20% 0% - 100%
3% 59% - 74%
74%
3%
31%
2%
0% - 100%
0% - 75%
70%
70%
42%
Total
$
316,948
$
226,836
$
420,205
$
(90,112)
All of the assumptions listed have some degree of market observability, based on Newcastle’s knowledge of the market, relationships with
market participants, and use of common market data sources. Collateral prepayment, default and loss severity projections are in the form of
“curves” or “vectors” that vary for each monthly collateral cash flow projection. Methods used to develop these projections vary by asset class
(e.g., CMBS projections are developed differently than Home Equity ABS projections) but conform to industry conventions. We use
assumptions that generate our best estimate of future cash flows of each respective security.
The prepayment vector specifies the percentage of the collateral balance that is expected to voluntarily pay off at each point in the future. The
prepayment vector is based on projections from the a widely published investment bank model which considers factors such as collateral FICO
score, loan-to-value ratio, debt-to-income ratio, and vintage on a loan level basis. This vector is scaled up or down to match recent collateral-
specific prepayment experience, as obtained from remittance reports and market data services.
Loss severities are based on recent collateral-specific experience with additional consideration given to collateral characteristics. Collateral age
is taken into consideration because severities tend to initially increase with collateral age before eventually stabilizing. We typically use
projected severities that are higher than the historic experience for collateral that is relatively new (e.g., 2007 vintage origination) to account for
this effect. Collateral characteristics such as loan size, lien position, and location (state) also effect loss severity. We consider whether a
collateral pool has experienced a significant change in its composition with respect to these factors when assigning severity projections.
Default vectors are determined from the current “pipeline” of loans that are more than 90 days delinquent, in foreclosure, or are real estate
owned (REO). These seriously delinquent loans determine the first 24 months of the default vector. Beyond month 24, the default vector
transitions to a steady-state value that is generally equal to or greater than that given by the widely published investment bank model.
The discount rates we use are derived from a range of observable pricing on securities backed by similar collateral and offered in a live market.
As the markets in which we transact have become less liquid, we have had to rely on fewer data points in this analysis.
(E) Lifetime average constant prepayment rate.
Valuation Hierarchy
The methodologies used for valuing such instruments have been categorized into three broad levels as follows:
Level 1 - Quoted prices in active markets for identical instruments.
Level 2 - Valuations based principally on other observable market parameters, including
• Quoted prices in active markets for similar instruments,
• Quoted prices in less active or inactive markets for identical or similar instruments,
• Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss
severities, credit risks and default rates), and
• Market corroborated inputs (derived principally from or corroborated by observable market data).
Level 3 - Valuations based significantly on unobservable inputs.
• Level 3A - Valuations based on third party indications (broker quotes, counterparty quotes or pricing
services) which were, in turn, based significantly on unobservable inputs or were otherwise not
supportable as Level 2 valuations.
• Level 3B - Valuations based on internal models with significant unobservable inputs.
86
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
These levels form a hierarchy. Newcastle follows this hierarchy for its financial instruments measured at fair value on a
recurring basis. The classifications are based on the lowest level of input that is significant to the fair value
measurement.
The following table summarizes such financial assets and liabilities at December 31, 2009:
Principal Balance
or Notional
Amount
Carrying
Value
Level 2
Level 3A
Level 3B
Total
Fair Value
Assets:
Real estate securities, available for sale:
CMBS
ABS - subprime
Subprime retained
Subprime residuals
ABS - other real estate
FNMA / FHLMC
REIT debt
Debt secuity total
Equity securities
Total
Liabilites:
Interest rate swaps, treated as hedges
Non-hedge derivatives
$
$
$
$
$
2,458,151
462,503
61,963
23
86,006
45,494
518,215
3,632,355
$
1,061,619
171,253
1,983
23
56,779
49,871
486,647
1,828,175
2,620
1,830,795
-
$
-
-
-
-
49,871
486,647
536,518
-
536,518
$
933,499
87,882
-
-
46,060
-
-
1,067,441
-
1,067,441
128,120
83,371
1,983
23
10,719
-
-
224,216
2,620
226,836
1,061,619
171,253
1,983
23
56,779
49,871
486,647
1,828,175
2,620
1,830,795
$
$
$
$
2,099,435
296,243
178,037
29,117
178,037
29,117
-
-
-
-
178,037
29,117
Newcastle’s investments in instruments measured at fair value using Level 3 inputs changed during the year ended
December 31, 2009 as follows:
Assets
Balance at January 1, 2008
Total gains (losses) (A)
Included in net income (loss) (B)
Included in other comprehensive income
Amortization included in interest income
Settlements or repayments
Transfers between Level 3A and Level 3B
Transfers into Level 3 (C) (D)
Transfers out of Level 3 (C)
Balance at December 31, 2008
Level 3A
Level 3B
Total
$
130,968
$
177,518
$
308,486
(1,565,353)
463,510
5,938
65,992
(176,008)
2,379,729
-
(441,862)
255,317
24,837
(75,000)
176,008
77,259
(14,314)
(2,007,215)
718,827
30,775
(9,008)
-
2,456,988
(14,314)
1,304,776
179,763
1,484,539
Level 3A
Level 3B
Total
1,304,776
$
Assets
Balance at January 1, 2009
Total gains (losses) (A)
Included in net income (loss) (B)
Reclassification related to the adoption of new impairment
guidance included in other comprehensive income
Included in other comprehensive income (loss)
Amortization included in interest income
Purchases
Proceeds from sales
Proceeds from repayments
Transfers between Level 3A and Level 3B
Transfers into Level 3 (C)
Transfers out of Level 3 (C) (E)
(128,682)
979,089
(499,307)
56,801
293,244
(93,180)
(178,046)
(156,720)
-
(510,534)
$
179,763
$
1,484,539
(401,563)
(530,245)
309,835
25,045
30,088
-
(30,939)
(42,113)
156,720
-
-
1,288,924
(474,262)
86,889
293,244
(124,119)
(220,159)
-
-
(510,534)
Balance at December 31, 2009
1,067,441
226,836
1,294,277
(A) None of the gains (losses) recorded in earnings during the periods is attributable to the change in unrealized gains (losses) relating to Level 3
assets still held at the reporting dates.
87
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
(B) These gains (losses) are recorded in the following line items in the consolidated statements of operations:
Year Ended December 31,
Gain (loss) on settlement of investments, net
Other income (loss), net
OTTI
Total
Gain (loss) on sale of investments, net, from
investments transferred into Level 3 during
the period
2009
$
6,672
(3,384)
(533,533)
(530,245)
2008
$
(9,306)
(213)
(1,997,696)
(2,007,215)
$
$
$
-
$
(8,868)
(C) Transfers are assumed to occur at the beginning of the quarter.
(D) As a result of the relative illiquidity in the mortgage-backed securities market, management determined that there was little or no price
transparency in the broker quotations used in the valuation of our CMBS, ABS and REIT debt as of September 30, 2008 and therefore
classified such securities as Level 3A assets under the fair value hierarchy.
(E) As a result of the increased liquidity and price transparency of the REIT debt securities, management transferred such securities into Level 2
under the fair value hierarchy in the fourth quarter of 2009.
During the year ended December 31, 2009, Newcastle recorded net valuation allowances (reversals) of $44.6 million
and ($29.6) million on real estate related loans and residential mortgage loans (Note 5), respectively. The impairments
relate to loans that were written down to fair value as a result of credit impairment, and held for sale loans that were
recorded on the balance sheet at the lower of cost or fair value. As a result, these loans are recorded at fair value at
December 31, 2009 but may not be carried at fair value in the future. During the year ended December 31, 2009,
Newcastle recorded an impairment charge of $0.6 million on our operating real estate held for sale, which was
recorded on the balance sheet at the lower of cost or fair value. The following table summarizes the level within the fair
value hierarchy at which the fair values of these assets were measured on a non-recurring basis at December 31, 2009:
Loan Type
Mezzanine Loans
Corporate Bank Loans
B-Notes
Whole Loans
Residential Loans
Manufactured Housing loans
Outstanding Face
Amount
$
718,298
314,134
308,082
93,305
1,433,819
69,930
414,233
484,163
Fair Value and Carrying Value
Level 3A
Level 3B
Total
$
52,592
198,828
-
-
251,420
-
-
-
$
187,593
-
79,427
55,422
322,442
53,995
329,652
383,647
$
240,185
198,828
79,427
55,422
573,862
53,995
329,652
383,647
Total financial assets measured at fair
value on a nonrecurring basis
$
1,917,982
$
251,420
$
706,089
$
957,509
Operating real estate held for sale
N/A
$
-
$
9,966
$
9,966
88
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
Derivatives
Newcastle’s derivatives are recorded on its balance sheet as follows:
December 31,
2009
2008
Derivative Liabilities
Interest rate swaps, treated as hedges
Non-hedge interest rate swaps
$
$
178,037
29,117
207,154
$
$
317,757
16,220
333,977
The following table summarizes financial information related to derivatives (excluding total rate of return swaps,
which are reported separately):
Cash flow hedges
Notional amount of interest rate swap agreements
Amount of (loss) recognized in OCI on effective portion
$
2,099,435
(173,683)
$
2,376,420
(312,431)
December 31,
2009
2008
Deferred hedge gain (loss) related to anticipated financings,
which have subsequently occurred, net of amortization
Deferred hedge gain (loss) related to dedesignation,
net of amortization
Expected reclassification of deferred hedges from AOCI into
earnings over the next 12 months
Expected reclassification of current hedges from AOCI into
earnings over the next 12 months
832
932
(8,045)
(2,825)
(4,234)
1,149
(90,666)
(19,570)
Non-hedge Derivatives
Notional amount of interest rate swap agreements
296,243
182,867
The following table summarizes gains (losses) recorded in relation to derivatives (excluding total rate of return
swaps, which are reported separately):
Cash flow hedges
Gain (loss) on the ineffective portion
Gain (loss) immediately recognized at dedesignation
Amount of gain (loss) reclassified from AOCI into income, related to
effective portion
Deferred hedge gain reclassified from AOCI into income, related to
anticipated financings
Deferred hedge gain (loss) reclassified from AOCI into income, related to
effective portion of dedesignated hedges
Fair value hedges
Gain (loss) on the effective portion (A)
Gain (loss) on the ineffective portion
Income Statement
Location
Year Ended December 31,
2008
2009
2007
Other Income (Loss)
Other Income (Loss)
$
(278)
(15,223)
$
180
(14,730)
$
(1,662)
(9,315)
Interest Expense
(100,046)
(62,013)
18,914
Interest Expense
101
Interest Expense
(9,547)
Other Income (Loss)
Other Income (Loss)
-
-
94
786
-
-
87
374
168
(48)
6,059
Non-hedge derivatives gain (loss)
Other Income (Loss)
15,446
(18,451)
(A) Offset by the unrealized gain (loss) on the associated hedged items which is recognized in earnings.
89
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
8. DEBT OBLIGATIONS
The following table presents certain information regarding Newcastle’s debt obligations and related hedges:
Debt Obligation/Collateral
Month Issued
CDO Bonds Payable
CDO IV (D)
CDO V (D)
CDO VI (D)
CDO VII (D)
CDO VIII
CDO IX
CDO X
Other Bonds Payable
MH Loans (E)
MH Loans (F)
Repurchase Agreements (G)
Real estate securities, loans and
properties
FNMA/FHLMC securities
Mar 2004
Sep 2004
Apr 2005
Dec 2005
Nov 2006
May 2007
Jul 2007
Jan 2006
Aug 2006
Various
Rolling
Corporate
Junior subordinated notes payable (H)
Mar 2006
Outstanding
Face
Amount
Carrying
Value
Unhedged
Weighted
Average
Funding Cost (A)
$
369,477
447,287
437,669
411,550
729,313
497,000
1,175,000
$
368,111
445,498
436,111
408,972
728,383
497,777
1,174,076
4,067,296
4,058,928
1.16%
0.94%
0.73%
0.73%
0.92%
0.74%
0.35%
Final Stated
Maturity
Mar 2039
Sep 2039
Apr 2040
Dec 2050
Nov 2052
May 2052
Jul 2052
107,003
197,397
304,400
31,672
39,637
71,309
102,500
102,500
107,003
196,694
303,697
31,672
39,637
71,309
103,264
103,264
LIBOR+0.75%
LIBOR+1.00%
Jan 2009 (E)
Aug 2011
LIBOR+2.13%
LIBOR+0.17%
Various
Jan 2010
1.00% (H)
Apr 2035
Subtotal debt obligations
Financing on subprime mortgage
loans subject to call option
Total debt obligations
4,545,505
4,537,198
(I)
406,217
403,006
$
4,951,722
$
4,940,204
December 31, 2009
December 31, 2008
Collateral
Weighted
Average
Funding
Cost (B)
Weighted
Average
Maturity
(Years)
Face
Amount
of Floating Rate
Debt
Outstanding
Face Amount
(C)
Amortized
Cost Basis (C)
Carrying
Value (C)
Weighted
Average
Maturity
(Years)
Aggregate
Notional
Amount of
Current Hedges
Outstanding
Face
Amount
Floating Rate
Face Amount (C)
Carrying
Value
3.00%
2.90%
3.10%
4.18%
1.98%
1.62%
4.51%
3.20%
5.12%
6.52%
6.03%
2.36%
5.01%
3.83%
7.28%
7.28%
3.49%
2.8
3.3
4.2
5.4
3.8
4.7
5.1
4.3
-
1.5
0.9
0.4
0.1
0.2
26.1
26.1
$
345,770
435,099
429,894
405,028
721,713
497,000
1,175,000
$
419,419
507,465
483,517
493,984
828,854
824,390
1,375,294
$
355,969
391,182
261,483
189,180
434,819
417,554
1,003,578
$
243,497
263,095
207,141
148,465
438,772
422,622
874,932
4,009,504
4,932,923
3,053,765
2,598,524
107,003
197,397
304,400
31,672
39,637
71,309
-
-
170,452
243,781
414,233
176,648
40,082
216,730
-
-
122,095
207,557
329,652
28,741
41,880
70,621
-
-
122,095
207,557
329,652
28,741
44,045
72,786
-
-
3.4
3.5
3.2
4.0
3.3
2.2
3.6
3.3
7.5
6.1
6.6
0.5
3.8
1.1
-
-
$
176,125
217,218
159,452
94,468
580,167
636,753
305,628
$
177,300
208,439
224,815
298,355
161,655
91,748
900,408
$
410,085
454,500
445,157
420,534
807,500
585,750
1,247,750
$
408,160
452,178
442,094
417,568
806,442
586,569
1,246,970
2,169,811
2,062,720
4,371,276
4,359,981
2,182
42,047
44,229
164,616
-
164,616
-
-
-
-
-
-
36,715
36,715
-
-
143,784
237,976
381,760
102,977
173,495
276,472
100,100
100,100
143,767
236,853
380,620
102,977
173,495
276,472
100,100
100,100
4.5
$
4,385,213
$
5,563,886
$
3,454,038
$
3,000,962
3.4
$
2,378,656
$
2,099,435
$
5,129,608
$
5,117,173
406,217
398,026
$
5,535,825
$
5,515,199
(A) Weighted average, including floating and fixed rate classes and excluding the amortization of deferred financing costs.
(B)
Including the effect of applicable hedges.
(C)
Including restricted cash held for reinvestment in CDOs. The face amount and carrying value of Newcastle’s unlevered investments (real estate loans and securities) were $190.3 million and $6.7 million, respectively, as of
December 31, 2009.
(D) CDOs IV, V, VI and VII were not in compliance with their applicable over collateralization tests as of December 31, 2009. Newcastle is not receiving cash flows from these CDOs (other than senior management fees) and expects
these CDOs to remain out of compliance for the foreseeable future.
(E) See further description below.
(F) Of which $10.2 million face amount is recourse financing.
(G) The counterparties on these repurchase agreements include: Goldman Sachs ($39.6 million of FNMA/FHLMC financing), Deutsche Bank ($15.7 million), and Citigroup ($16.0 million). The non-FNMA/FHLMC financings are
subject to scheduled repayments, with the final payment to be made in June 2010.
(H)
In April 2009, Newcastle entered into an exchange agreement with the holder of the trust preferred securities under which Newcastle will effectively be accruing interest at a rate of 1.0% per annum beginning February 1, 2009 for
a maximum of six quarters, after which the rate reverts to 7.574% through April 2016 and to LIBOR + 2.25% after April 2016. Pursuant to the exchange, a real estate loan, which was valued at $4.1 million on December 31, 2009,
was pledged as collateral for the junior subordinated notes and will be released at the end of the interest rate modification period.
(I)
Issued in April 2006 and July 2007. See Note 5 regarding the securitizations of Subprime Portfolios I and II.
Certain of the debt obligations included above are obligations of consolidated subsidiaries of Newcastle which own the related collateral. In some cases, including
the CDO and Other Bonds Payable, such collateral is not available to other creditors of Newcastle.
90
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
CDO Bonds Payable
In June and July 2007, Newcastle refinanced three prior CDO issuances with a single CDO issuance which aggregated
$1,248 million of issued debt. Newcastle incurred $4.7 million of cash expenses and $8.2 million of non-cash charges
in connection with this extinguishment of debt.
In February 2008, Newcastle repaid in full the debt associated with its first CDO.
During 2008, Newcastle repurchased $24.9 million face amount of CDO bonds for $7.9 million and recorded a gain of
$16.8 million. During 2009, Newcastle repurchased $246.7 million of CDO bonds for $29.9 million and recorded a
gain of $215.3 million.
Since the filing of Newcastle’s Quarterly Report on Form 10-Q for the period ended September 30, 2009 on November
4, 2009, CDO VII failed additional over collateralization tests. The consequences of failing these tests are that an
event of default has occurred and Newcastle may be removed as the collateral manager under the documentation
governing CDO VII. So long as the event of default continues, Newcastle will not be permitted to purchase or sell any
collateral in CDO VII. If Newcastle is removed as the collateral manager of CDO VII, it would no longer receive the
senior management fees from such CDO. As of February 17, 2010, Newcastle has not been removed as collateral
manager. Newcastle does not expect the failure of these additional tests to have a material negative impact on our cash
flows, business, results of operations or financial condition.
As of February 17, 2010, CDOs IV, V, VI and VII, were not in compliance with their applicable over collateralization
tests and, consequently, Newcastle was not receiving cash flows from these CDOs currently (other than senior
management fees). Based upon Newcastle’s current calculations, Newcastle expects these four portfolios to remain out
of compliance for the foreseeable future. Moreover, given current market conditions, it is possible that all of
Newcastle’s CDOs could be out of compliance with their over collateralization tests as of one or more measurement
dates within the next twelve months.
Other Bonds Payable
In January 2009, the debt for one of Newcastle’s manufactured housing loan portfolios ($107.0 million outstanding at
December 31, 2009) became callable at the option of the lender. The principal and interest payments from the
underlying loans, net of expenses and payments related to interest rate swap contracts, are used to repay the
outstanding debt on a monthly basis.
Repurchase Agreements Subject to ABCP Facility
In December 2006, Newcastle closed a $2 billion asset backed commercial paper (ABCP) facility which provided
Newcastle with the ability to finance its FNMA/FHLMC securities with ABCP. In August through November 2007,
Newcastle refinanced this debt with repurchase agreements. As a result, a non-cash expense of $3.5 million was
recorded related to the write-off of deferred financing costs and other hedge related items.
Credit Facility
In February 2008, Newcastle terminated its credit facility. The credit facility had been unused since July 2007 and the
termination released a significant amount of collateral with which it generated additional liquidity, generally through
selective asset sales. At the date of termination, no amounts were outstanding under the credit facility (and Newcastle
did not incur any material costs related to the termination); at that time, previously incurred and deferred financing
costs of $0.6 million were written off.
Junior Subordinated Notes Payable
In March 2006, Newcastle completed the placement of $100 million of trust preferred securities through its wholly
owned subsidiary, Newcastle Trust I (the “Preferred Trust”). Newcastle owns all of the common stock of the Preferred
Trust. The Preferred Trust used the proceeds to purchase $100.1 million of Newcastle’s junior subordinated notes.
These notes represent all of the Preferred Trust’s assets. The terms of the junior subordinated notes are substantially the
same as the terms of the trust preferred securities.
91
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
On April 30, 2009, Newcastle entered into an exchange agreement with several collateralized debt obligations
managed by a third party pursuant to which Newcastle agreed to exchange newly issued junior subordinated notes due
in 2035 with an initial aggregate principal amount of $101.7 million (the "Notes") for $100 million in aggregate
liquidation amount of trust preferred securities that were previously issued by a subsidiary of Newcastle (the “TRUPs”)
and were owned by the third party. The Notes accrue interest at a rate of 1.0% per year for a maximum of six quarters,
beginning on February 1, 2009 and the aggregate principal amount of the Notes will increase to $104.9 million by July
30, 2010. Subsequent to that period, the rate reverts to that which Newcastle was required to pay on the TRUPs
(7.574% through April 2016 and at a floating rate of 3-month LIBOR plus 2.25% thereafter). In conjunction with the
exchange, the TRUPs were cancelled and Newcastle pledged 100% of its equity interests in NIC TP LLC, a special
purpose subsidiary that holds Newcastle’s participation in a loan and related deposit account, which were valued at
$4.1 million on December 31, 2009, as collateral. The pledged collateral will be released at the end of the interest rate
modification period. Under the provisions of ASC 470-60, “Troubled Debt Restructurings by Debtors”, this exchange
is considered a troubled debt restructuring which requires Newcastle to account for the effect of the interest
modification prospectively and to record the expenses related to the modification immediately through earnings.
On January 29, 2010, Newcastle Investment Corp. (together with its wholly-owned taxable REIT subsidiary, NIC TRS
LLC, the “Company”), entered into an Exchange Agreement, dated as of January 29, 2010 (the “Exchange
Agreement”), with Taberna Capital Management, LLC and certain of its affiliates (collectively, “Taberna”), pursuant
to which the Company and Taberna agreed to exchange (the “Exchange”) approximately $51.9 million aggregate
principal amount of junior subordinated notes due 2035 for approximately $37.6 million face amount of previously
issued CDO securities and approximately $9.7 million of cash held by the Company. In other words, $51.9 million
face amount of the company’s debt, in the form of junior subordinated notes payable, was repurchased and effectively
retired in exchange for (i) the payment of $9.7 million of cash, and (ii) the reissuance of $37.6 million face amount of
CDO bonds payable (which had previously been repurchased by the Company). In connection with the Exchange, the
Company paid or reimbursed certain expenses incurred by Taberna, various indenture trustees and their respective
advisors in accordance with the terms of the Exchange Agreement. The Company is currently evaluating the impact of
this exchange on its financial results, which will be recorded in the first quarter of 2010.
Maturity Table
Newcastle’s debt obligations (gross of $11.5 million of discounts at December 31, 2009) have contractual maturities as
follows:
2010
2011
2012
2013
2014
Thereafter
Total
Debt Covenants
Nonrecourse
107,003
$
187,191
-
-
-
4,473,513
4,767,707
$
Recourse
$
81,515
-
-
-
-
102,500
184,015
$
Total
188,518
187,191
-
-
-
4,576,013
4,951,722
$
$
Newcastle’s non-CDO financings contain various customary loan covenants. Newcastle was in compliance with all of
the covenants in its non-CDO financings as of February 17, 2010.
9. STOCK OPTION PLAN AND EARNINGS PER SHARE
Newcastle is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by
dividing net income available for common stockholders by the weighted average number of shares of common stock
outstanding during each period. Diluted EPS is calculated by dividing net income available for common stockholders
by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common
stock equivalents during each period. Newcastle’s common stock equivalents are its stock options. During 2009, 2008
and 2007, Newcastle had no dilutive common stock equivalents (common stock equivalents are not dilutive in periods
of net loss). Net income available for common stockholders is equal to net income less preferred dividends.
In June 2002, Newcastle (with the approval of the board of directors) adopted a nonqualified stock option and incentive
award plan (the "Newcastle Option Plan'') for officers, directors, consultants and advisors, including the Manager and
92
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
its employees. The maximum available for issuance is equal to 10% of the number of outstanding equity interests of
Newcastle, subject to a maximum of 10,000,000 shares in the aggregate over the term of the plan.
Upon joining the board, the non-employee directors have been, in accordance with the Newcastle Option Plan,
automatically granted options to acquire an aggregate of 18,000 shares of common stock. The fair value of such
options was not material at the date of grant.
Through December 31, 2009, for the purpose of compensating the Manager for its successful efforts in raising capital
for Newcastle, the Manager has been granted options representing the right to acquire 3,523,727 shares of common
stock, with strike prices subject to adjustment as necessary to preserve the value of such options in connection with the
occurrence of certain events (including capital dividends and capital distributions made by Newcastle). The Manager
options represented an amount equal to 10% of the shares of common stock of Newcastle sold in its public offerings
and the value of such options was recorded as an increase in stockholders’ equity with an offsetting reduction of capital
proceeds received. The options granted to the Manager, which may be assigned by the Manager to its employees, were
fully vested on the date of grant and one thirtieth of the options become exercisable on the first day of each of the
following thirty calendar months, or earlier upon the occurrence of certain events, such as a change in control of
Newcastle or the termination of the Management Agreement. The options expire ten years from the date of issuance.
As of December 31, 2009, Newcastle’s outstanding options were summarized as follows:
Held by the Manager
Issued to the Manager and subsequently assigned
to certain of the Manager's employees
Held by directors and former directors
Total
1,686,447
798,162
14,000
2,498,609
The following table summarizes Newcastle’s outstanding options at December 31, 2009. Note that the last sales price
on the New York Stock Exchange for Newcastle’s common stock in the year ended December 31, 2009 was $2.09 per
share.
Recipient
Directors
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Manager (C)
Exercised (C)
Outstanding
Date of
Grant/Exercise
Various
2002
2003
2004
2005
2006
2007
Prior to 2008
Number of Options
18,000
700,000
788,227
837,500
330,000
170,000
698,000
(1,043,118)
2,498,609
Weighted Average
Exercise Price (A)
$16.98
$12.60
$20.99
$26.66
$29.20
$29.02
$28.58
$15.70
$26.64
Fair Value At Grant
Date (Millions) (B)
Not Material
$0.4
$1.2
$1.6
$1.1
$0.5
$2.0
(A) The strike prices are subject to adjustment in connection with return of capital dividends. A portion of Newcastle’s 2008 dividends was deemed
return of capital dividends. The effect on the strike prices was not significant.
(B) The fair value of the options was estimated using a lattice-based option valuation model. Since the Newcastle Option Plan has characteristics
significantly different from those of traded options, and since the assumptions used in such model, particularly the volatility assumption, are
subject to significant judgment and variability, the actual value of the options could vary materially from management’s estimate. The
assumptions used in such model for the last three years were as follows:
Date of Grant
January 2007
April 2007
Volatility
21%
21%
Dividend Yield
8.82%
9.95%
Expected Life (Years)
5
5
Risk-Free Rate
4.77%
4.65%
The volatility assumption for these options was estimated based primarily on the historical volatility of
Newcastle’s common stock and management’s expectations regarding future volatility. The expected life
assumption for these options was estimated based on the simplified term method. This simplified method was used
because Newcastle did not have sufficient historical data to conclude on the appropriate expected life of its options
and because historical data to date was consistent with the simplified term method.
93
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
(C) The Manager assigned certain of its options to its employees as follows:
Date of Grant
2002
2003
2004
2005
2006
2007
Range of
Strike Prices
$13.00
$20.35-$22.85
$25.75-$31.40
$29.60
$29.42
$27.75-$31.30
Total
Total Unexercised
Inception to Date
17,500
164,197
226,125
90,750
65,025
234,565
798,162
670,620 of the total options exercised were by the Manager. 368,498 of the total options exercised were by employees
of the Manager subsequent to their assignment. 4,000 of the total options exercised were by directors.
10. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS
Manager
Newcastle entered into the Management Agreement with the Manager in June 2002, as amended, which provided for
an initial term of one year with automatic one year extensions, subject to certain termination rights. After the initial one
year term, the Manager's performance is reviewed annually and the Management Agreement may be terminated by
Newcastle by payment of a termination fee, as defined in the Management Agreement, equal to the amount of
management fees earned by the Manager during the twelve consecutive calendar months immediately preceding the
termination, upon the affirmative vote of at least two-thirds of the independent directors, or by a majority vote of the
holders of common stock. Pursuant to the Management Agreement, the Manager, under the supervision of Newcastle’s
board of directors, formulates investment strategies, arranges for the acquisition of assets, arranges for financing,
monitors the performance of Newcastle's assets and provides certain advisory, administrative and managerial services
in connection with the operations of Newcastle. For performing these services, Newcastle pays the Manager an annual
management fee equal to 1.5% of the gross equity of Newcastle, as defined, including adjustments for return of capital
dividends.
The Management Agreement provides that Newcastle will reimburse the Manager for various expenses incurred by the
Manager or its officers, employees and agents on Newcastle's behalf, including costs of legal, accounting, tax, auditing,
administrative and other similar services rendered for Newcastle by providers retained by the Manager or, if provided
by the Manager's employees, in amounts which are no greater than those which would be payable to outside
professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm's-length
basis.
To provide an incentive for the Manager to enhance the value of the common stock, the Manager is entitled to receive
an incentive return (the "Incentive Compensation'') on a cumulative, but not compounding, basis in an amount equal to
the product of (A) 25% of the dollar amount by which (1) (a) the Funds from Operations, as defined (before the
Incentive Compensation) of Newcastle per share of common stock (based on the weighted average number of shares of
common stock outstanding) plus (b) gains (or losses) from debt restructuring and from sales of property and other
assets per share of common stock (based on the weighted average number of shares of common stock outstanding),
exceed (2) an amount equal to (a) the weighted average of the price per share of common stock in the IPO and the
value attributed to the net assets transferred to Newcastle by its predecessor, and in any subsequent offerings by
Newcastle (adjusted for prior return of capital dividends or capital distributions) multiplied by (b) a simple interest rate
of 10% per annum (divided by four to adjust for quarterly calculations) multiplied by (B) the weighted average number
of shares of common stock outstanding. As a result of the effect of recording other-than-temporary impairment,
Newcastle expects that there will be no Incentive Compensation payable to the Manager for an indeterminate period of
time.
Management Fee………………………
Expense Reimbursement…………….
Incentive Compensation………………
Amounts Incurred (in millions)
2008
$17.9
0.5
-
2007
$17.1
0.5
6.2
2009
$17.5
0.5
-
At December 31, 2009, the Manager, through its affiliates, and principals of Fortress, owned 3.8 million shares of
Newcastle’s common stock and the Manager, through its affiliates, had options to purchase an additional 1.7 million
shares of Newcastle’s common stock (Note 9).
94
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
In 2009, principals of Fortress sold an aggregate of 1.1 million common shares of Newcastle to third parties at market
prices.
At December 31, 2009 and December 31, 2008, Due To Affiliates is comprised of $1.5 million and $1.5 million,
respectively, of management fees and expense reimbursements payable to the Manager.
Other Affiliates
In November 2003, Newcastle and a private investment fund managed by an affiliate of its manager co-invested and
each indirectly own an approximately 38% interest in a limited liability company (Note 3) that has acquired a pool of
franchise loans from a third party financial institution. Newcastle’s investment in this entity, reflected as an investment
in an unconsolidated subsidiary on Newcastle’s consolidated balance sheet, was approximately $0.2 million at
December 31, 2009. The remaining approximately 24% interest in the limited liability company is owned by the
above-referenced third party financial institution.
In April 2006, Newcastle securitized Subprime Portfolio I and, through Securitization Trust 2006, entered into a
servicing agreement with a subprime home equity mortgage lender (the “Subprime Servicer”) to service this portfolio.
In July 2006, private equity funds managed by an affiliate of Newcastle’s manager completed the acquisition of the
Subprime Servicer. As compensation under the servicing agreement, the Subprime Servicer will receive, on a monthly
basis, a net servicing fee equal to 0.5% per annum on the unpaid principal balance of the portfolio. In March 2007,
through Securitization Trust 2007, Newcastle entered into a servicing agreement with the Subprime Servicer to service
Subprime Portfolio II under substantially the same terms. The outstanding unpaid principal balances of Subprime
Portfolios I and II were approximately $587.4 million and $785.0 million at December 31, 2009, respectively.
As of December 31, 2009, Newcastle held on its balance sheet total investments of $231.5 million face amount of real
estate securities and related loans issued by affiliates of the Manager. Newcastle earned approximately $15.1 million,
$20.4 million and $20.1 million of interest on investments issued by affiliates of the Manager for the years ended
December 31, 2009, 2008 and 2007, respectively.
In each instance described above, affiliates of Newcastle’s manager have an investment in the applicable affiliated fund
and receive from the fund, in addition to management fees, incentive compensation if the fund’s aggregate investment
returns exceed certain thresholds.
11. COMMITMENTS AND CONTINGENCIES
Stockholder Rights Agreement ⎯ Newcastle has adopted a stockholder rights agreement (the "Rights Agreement'').
Pursuant to the terms of the Rights Agreement, Newcastle will attach to each share of common stock one preferred
stock purchase right (a "Right''). Each Right entitles the registered holder to purchase from Newcastle a unit consisting
of one one-hundredth of a share of Series A Junior Participation Preferred Stock, par value $0.01 per share, at a
purchase price of $70 per unit. Initially, the Rights are not exercisable and are attached to and transfer and trade with
the outstanding shares of common stock. The Rights will separate from the common stock and will become
exercisable upon the acquisition or tender offer to acquire a 15% beneficial ownership interest by an acquiring person,
as defined. The effect of the Rights Agreement will be to dilute the acquiring party's beneficial interest. Until a Right is
exercised, the holder thereof, as such, will have no rights as a stockholder of Newcastle.
Litigation ⎯ Newcastle is, from time to time, a defendant in legal actions from transactions conducted in the ordinary
course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such
actions which existed at December 31, 2009, if any, will not materially affect Newcastle’s consolidated results of
operations or financial position.
Environmental Costs ⎯ As a commercial real estate owner, Newcastle is subject to potential environmental costs. At
December 31, 2009, management of Newcastle is not aware of any environmental concerns that would have a material
adverse effect on Newcastle's consolidated financial position or results of operations.
Debt Covenants ⎯ Newcastle's debt obligations contain various customary loan covenants. Furthermore, the maturity
date of one of Newcastle’s debt obligations has passed. See Note 8.
Subprime Securitizations ⎯ Newcastle has no obligation to repurchase any loans from either of its subprime
securitizations. Therefore, it is expected that Newcastle’s exposure to loss is limited to the carrying amount of its
retained interests in the securitization entities (Note 5). A subsidiary of Newcastle’s gave limited representations and
95
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
warranties with respect to the second securitization; however, it has no assets and does not have recourse to the general
credit of Newcastle.
Preferred Dividends in Arrears ⎯ As of December 31, 2009 and December 31, 2008, $15.8 million and $2.3 million,
respectively, of dividends on Newcastle’s cumulative preferred stock were unpaid and in arrears.
Contingent Gain in CDOs ⎯ Newcastle has recorded $1.0 billion of losses in its CDOs in excess of its economic
exposure which must eventually be reversed through amortization, sales at gains, or as gains at the deconsolidation or
termination of the CDOs. See Notes 3, 4 and 5.
12. INCOME TAXES AND DIVIDENDS
Newcastle Investment Corp. is organized and conducts its operations to qualify as a REIT under the Code. A REIT
will generally not be subject to U.S. federal corporate income tax on that portion of its net income that is distributed to
stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and
complies with various other requirements. Up to 90% of this distribution requirement may be met through stock
dividends rather than cash, subject to limitations based on the value of Newcastle’s stock.
Since Newcastle distributed 100% of its 2009, 2008 and 2007 REIT taxable income (if any), no provision has been
made for U.S. federal corporate income taxes in the accompanying consolidated financial statements.
Common Stock distributions relating to 2009, 2008, and 2007 were taxable as follows:
Dividends Per Share (A)
Book Basis
$0.000
$0.750
Tax Basis
$0.000
$0.750
Ordinary/
Qualified Income
0.00%
46.31%
Capital
Gains
None
None
Return of Capital
0.00%
53.69%
2009
2008
2007
(A) Any excess of book basis dividends over tax basis dividends would generally be carried forward to the next year for tax purposes.
100.00%
$2.850
$2.850
None
None
During 2009, Newcastle repurchased $246.7 million face amount of its outstanding CDO debt at a discount and
recorded a $215.3 million gain. The gain recorded upon such cancellation of indebtedness is characterized as ordinary
income for tax purposes. In compliance with current tax laws, Newcastle has the ability to defer such ordinary income
to future years and intends to defer all or a portion of such gain for 2009.
As of December 31, 2008, Newcastle had a net operating loss carryforward of $(182.4) million. In addition, Newcastle
had a net long-term capital loss carryforward of $(198.5) million. The net operating loss carryforward and capital loss
carryforward can generally be used to offset ordinary taxable income and taxable capital gains, respectively, in future
years. The amounts of net operating loss carryforward and net long-term capital loss carryforward as of December 31,
2009 will be subject to the finalization of the 2009 tax returns and could be materially different from such amounts as
of December 31, 2008.
13. SUBSEQUENT EVENTS
These financial statements include a discussion of material events which have occurred subsequent to December 31,
2009 (referred to as “subsequent events”) through the issuance of these consolidated financial statements on February
19, 2010. Events subsequent to that date have not been considered in these financial statements.
On January 29, 2010, Newcastle Investment Corp. (together with its wholly-owned taxable REIT subsidiary, NIC TRS
LLC, the “Company”), entered into an Exchange Agreement, dated as of January 29, 2010 (the “Exchange
Agreement”), with Taberna Capital Management, LLC and certain of its affiliates (collectively, “Taberna”), pursuant
to which the Company and Taberna agreed to exchange (the “Exchange”) approximately $51.9 million aggregate
principal amount of junior subordinated notes due 2035 for approximately $37.6 million face amount of previously
issued CDO securities and approximately $9.7 million of cash held by the Company. In other words, as of February
11, 2010, $51.9 million face amount of the company’s debt, in the form of junior subordinated notes payable, was
repurchased and effectively retired in exchange for (i) the payment of $9.7 million of cash, and (ii) the reissuance of
$37.6 million face amount of CDO bonds payable (which had previously been repurchased by the Company). In
connection with the Exchange, the Company paid or reimbursed certain expenses incurred by Taberna, various
indenture trustees and their respective advisors in accordance with the terms of the Exchange Agreement. The
Company is currently evaluating the impact of this exchange on its financial results, which will be recorded in the first
quarter of 2010.
96
NEWCASTLE INVESTMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007
(dollars in tables in thousands, except per share data)
14. SUMMARY QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following is unaudited summary information on Newcastle’s quarterly operations.
Basic
Diluted
$
-
$
-
$
-
$
-
$
-
$
-
$
$
(0.01)
(0.01)
$
$
(0.01)
(0.01)
Weighted average number of shares of common stock outstanding
52,807
52,807
52,836
52,836
52,905
52,905
52,905
52,905
52,864
52,864
2009
Interest income
Interest expense
Net interest income (expense)
Impairment
Other income (loss) (B)
Equity in earnings of unconsolidated subsidiaries (C)
Depreciation and amortization
Other operating expenses
Income (loss) from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Income (loss) applicable to common stockholders
Net income (loss) per share of common stock
Basic
Diluted
Income (loss) from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
Basic
Diluted
2008
Interest income
Interest expense
Net interest income (expense)
Impairment
Other income (loss) (B)
Equity in earnings of unconsolidated subsidiaries (C)
Depreciation and amortization
Other operating expenses
Income (loss) from continuing operations
Income (loss) from discontinued operations
Preferred dividends
Income (loss) applicable to common stockholders
Net income (loss) per share of common stock
Basic
Diluted
Income (loss) from continuing operations per share of common
stock, after preferred dividends and related accretion
Basic
Diluted
Income (loss) from discontinued operations per share of common stock
124,473
60,544
63,929
307,470
12,304
13
72
7,519
(238,815)
(33)
(3,375)
(242,223)
132,894
89,375
43,519
69,203
(4,249)
708
72
7,919
(37,216)
(3,688)
(3,375)
(44,279)
March 31 (A)
June 30 (A)
Quarter Ended
December 31
Year Ended
December 31
$
$
$
$
$
87,338
54,172
33,166
123,407
55,313
(28)
73
8,827
(43,856)
(142)
(3,376)
(47,374)
September 30 (A)
75,222
52,438
22,784
90,802
128,573
296
73
7,819
52,959
79
(3,375)
49,663
74,833
51,256
23,577
26,861
30,789
139
72
7,446
20,126
(222)
(3,375)
16,529
361,866
218,410
143,456
548,540
226,979
420
290
31,611
(209,586)
(318)
(13,501)
(223,405)
$
$
$
$
$
$
$
(4.59)
(4.59)
$
$
(0.90)
(0.90)
$
$
0.94
0.94
$
$
0.31
0.31
$
$
(4.23)
(4.23)
$
$
(4.59)
(4.59)
$
$
(0.90)
(0.90)
$
$
0.94
0.94
$
$
0.32
0.32
$
$
(4.22)
(4.22)
March 31 (A)
June 30 (A)
Quarter Ended
December 31
Year Ended
December 31
$
$
$
$
$
115,018
73,713
41,305
120,424
1,390
7,062
73
8,277
(79,017)
(5,263)
(3,376)
(87,656)
September 30 (A)
113,549
73,651
39,898
162,955
(15,166)
419
73
8,450
(146,327)
227
(3,375)
(149,475)
107,406
70,564
36,842
2,639,248
(102,941)
(32)
71
7,688
(2,713,138)
(930)
(3,375)
(2,717,443)
468,867
307,303
161,564
2,991,830
(120,966)
8,157
289
32,334
(2,975,698)
(9,654)
(13,501)
(2,998,853)
$
$
$
$
$
$
$
(0.84)
(0.84)
$
$
(1.66)
(1.66)
$
$
(2.83)
(2.83)
$
$
(51.48)
(51.48)
$
$
(56.81)
(56.81)
$
$
(0.77)
(0.77)
$
$
(1.56)
(1.56)
$
$
(2.84)
(2.84)
$
$
(51.46)
(51.46)
$
$
(56.63)
(56.63)
Basic
Diluted
$
$
(0.07)
(0.07)
$
$
(0.10)
(0.10)
$
$
0.01
0.01
$
$
(0.02)
(0.02)
$
$
(0.18)
(0.18)
Weighted average number of shares of common stock outstanding
Basic
Diluted
(A)
(B)
(C)
52,780
52,780
52,783
52,783
52,789
52,789
52,789
52,789
52,785
52,785
The Income Available for Common Stockholders shown agrees with Newcastle’s quarterly report(s) on Form 10-Q as filed with the Securities
and Exchange Commission. However, individual line items may vary from such report(s) due to the operations of properties sold, or classified
as held for sale, during subsequent periods being retroactively reclassified to Income for Discontinued Operations for all periods presented
(Note 5).
Excluding equity in earnings of unconsolidated subsidiaries.
Net of income taxes on related taxable subsidiaries, if any.
97
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
(a) Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d –15(e) under the Securities Exchange Act of 1934,
as amended (the “Exchange Act”)) as of the end of the period covered by this report. The Company’s disclosure
controls and procedures are designed to provide reasonable assurance that information is recorded, processed,
summarized and reported accurately and on a timely basis. Based on such evaluation, the Company’s Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure
controls and procedures are effective.
(b) Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Acts) during the most
recent fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially
affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial
reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Securities
Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, the Company’s principal
executive and principal financial officers and effected by the Company’s board of directors, management and other
personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with accounting principles generally accepted in the United States and
includes those policies and procedures that:
•
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions
and dispositions of the assets of the Company;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the United States, and that
receipts and expenditures of the Company are being made only in accordance with authorizations of
management and directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or
disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements.
Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31,
2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on our assessment, management concluded that, as of December 31, 2009, the Company’s internal control over
financial reporting was effective.
The Company’s independent registered public accounting firm has issued an audit report on the effectiveness of the
Company’s internal control over financial reporting. This report appears at the beginning of “Financial Statements and
Supplementary Data.”
By: /s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
By: /s/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer
98
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
Incorporated by reference to our definitive proxy statement for the 2010 annual meeting of stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
within 120 days after the fiscal year ended December 31, 2009.
Item 11. Executive Compensation.
Incorporated by reference to our definitive proxy statement for the 2010 annual meeting of stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
within 120 days after the fiscal year ended December 31, 2009.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Incorporated by reference to our definitive proxy statement for the 2010 annual meeting of stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
within 120 days after the fiscal year ended December 31, 2009.
Item 13. Certain Relationships and Related Transactions, Director Independence.
Incorporated by reference to our definitive proxy statement for the 2010 annual meeting of stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
within 120 days after the fiscal year ended December 31, 2009.
Item 14. Principal Accountant Fees and Services.
Incorporated by reference to our definitive proxy statement for the 2010 annual meeting of stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
within 120 days after the fiscal year ended December 31, 2009.
99
PART IV
Item 15. Exhibits; Financial Statement Schedules.
(a) and (c) Financial statements and schedules:
See “Financial Statements and Supplementary Data.”
(b) Exhibits filed with this Form 10-K:
3.1 Articles of Amendment and Restatement (incorporated by reference to the Registrant’s Registration Statement
on Form S-11 (File No. 333-90578), Exhibit 3.1).
3.2 Articles Supplementary relating to the Series B Preferred Stock (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 Articles Supplementary relating to the Series C Preferred Stock (incorporated by reference to the Registrant’s
Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005).
3.4 Articles Supplementary relating to the Series D Preferred Stock (incorporated by reference to the Registrant’s
Report on Form 8-A, Exhibit 3.1, filed on March 14, 2007).
3.5 Amended and Restated By-laws (incorporated by reference to the Registrant’s Current Report on Form 8-K,
Exhibit 3.1, filed on May 5, 2006).
4.1 Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as Rights Agent,
dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the
period ended September 30, 2003, Exhibit 4.1).
4.2
4.3
4.4
Junior Subordinated Indenture between Newcastle Investment Corp. and The Bank of New York Mellon Trust
Company, National Association, dated April 30, 2009 (incorporated by reference to the Registrant’s Report
on Form 8-K, Exhibit 4.1, filed on May 4, 2009).
Pledge and Security Agreement between Newcastle Investment Corp. and The Bank of New York Mellon
Trust Company, National Association, as trustee, dated April 30, 2009 (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 4.2, filed on May 4, 2009).
Pledge, Security Agreement and Account Control Agreement among Newcastle Investment Corp., NIC TP
LLC, as pledgor, and The Bank of New York Mellon Trust Company, National Association, as bank and
trustee, dated April 30, 2009 (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 4.3,
filed on May 4, 2009).
10.1 Amended and Restated Management and Advisory Agreement by and among the Registrant and FIG LLC
(formerly known as Fortress Investment Group LLC), dated June 23 2003 (incorporated by reference to the
Registrant’s Statement on Form S-11 (File No. 333-106135), Exhibit 10.1).
10.2 Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan Amended and Restated
Effective as of February 11, 2004 (incorporated by reference to the Registrant’s Annual Report on Form 10-K
for the year ended December 31, 2005, Exhibit 10.2).
10.3 Exchange Agreement between Newcastle Investment Corp. and Taberna Preferred Funding IV, Ltd., Taberna
Preferred Funding V, Ltd., Taberna Preferred Funding VI, Ltd. and Taberna Preferred Funding VII, Ltd.,
dated April 30, 2009 (incorporated by reference to the Registrant’s Report on Form 8-K, Exhibit 10.1, filed on
May 4, 2009).
10.4 Exchange Agreement, dated as of January 29, 2010, by and among Newcastle Investment Corp., Taberna
Capital Management, LLC, Taberna Preferred Funding IV, Ltd., Taberna Preferred Funding V, Ltd., Taberna
Preferred Funding VI, Ltd. and Taberna Preferred Funding VII, Ltd. (incorporated by reference to the
Registrant’s Report on Form 8-K, Exchibt 10.1, filed on February 2, 2010).
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
31.1 Certification of Chief Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
100
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, as amended, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:
SIGNATURES
NEWCASTLE INVESTMENT CORP.
February 19, 2010
By: /s/ Wesley R. Edens
Wesley R. Edens
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the
following person on behalf of the Registrant and in the capacities and on the dates indicated.
February 19, 2010
By: /s/ Kenneth M. Riis
Kenneth M. Riis
Director and Chief Executive Officer
February 19, 2010
By: /s/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer
February 19, 2010
By: /s/ Kevin J. Finnerty
Kevin J. Finnerty
Director
February 19, 2010
By: /s/ Stuart A. McFarland
Stuart A. McFarland
Director
February 19, 2010
By: /s/ David K. McKown
David K. McKown
Director
February 19, 2010
By: /s/ Peter M. Miller
Peter M. Miller
Director
101
SPECIAL NOTE REGARDING EXHIBITS
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K, please remember they are included
to provide you with information regarding their terms and are not intended to provide any other factual or disclosure
information about the Company or the other parties to the agreements. The agreements contain representations and
warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely
for the benefit of the other parties to the applicable agreement and:
•
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk
tone of the parties if those statements provide to be inaccurate;
have been qualified by disclosures that were made to the other party in connection wit the negotiation of the
applicable agreement, which disclosures are not necessarily reflected in the agreement;
• may apply standards of materiality in a way that is different from what may be viewed as material to you or other
investors; and
• were made only as of the date of the applicable agreement or such other date or dates as may be specified in the
agreement and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made
or at any other time. Additional information about the Company may be found elsewhere in this Annual Report on
Form 10-K and the Company’s other public filings, which are available without charge through the SEC’s website at
http://www.sec.gov. See “Where You Can Find More Information.”
Exhibit Index
3.1 Articles of Amendment and Restatement (incorporated by reference to the Registrant’s Registration
Statement on Form S-11 (File No. 333-90578), Exhibit 3.1).
3.2 Articles Supplementary relating to the Series B Preferred Stock (incorporated by reference to the
Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003, Exhibit 3.3).
3.3 Articles Supplementary relating to the Series C Preferred Stock (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 3.3, filed on October 25, 2005).
3.4 Articles Supplementary relating to the Series D Preferred Stock (incorporated by reference to the
Registrant’s Report on Form 8-A, Exhibit 3.1, filed on March 14, 2007).
3.5 Amended and Restated By-laws (incorporated by reference to the Registrant’s Current Report on Form
8-K (Exhibit 3.1, filed on May 5, 2006).
4.1 Rights Agreement between the Registrant and American Stock Transfer and Trust Company, as Rights
Agent, dated October 16, 2002 (incorporated by reference to the Registrant’s Quarterly Report on Form
10-Q for the period ended September 30, 2002, Exhibit 4.1).
4.2
4.3
4.4
Junior Subordinated Indenture between Newcastle Investment Corp. and The Bank of New York
Mellon Trust Company, National Association, dated April 30, 2009 (incorporated by reference to the
Registrant’s Report on Form 8-K, Exhibit 4.1, filed on May 4, 2009).
Pledge and Security Agreement between Newcastle Investment Corp. and The Bank of New York
Mellon Trust Company, National Association, as trustee, dated April 30, 2009 (incorporated by
reference to the Registrant’s Report on Form 8-K, Exhibit 4.2, filed on May 4, 2009).
Pledge, Security Agreement and Account Control Agreement among Newcastle Investment Corp., NIC
TP LLC, as pledgor, and The Bank of New York Mellon Trust Company, National Association, as
bank and trustee, dated April 30, 2009 (incorporated by reference to the Registrant’s Report on Form 8-
K, Exhibit 4.3, filed on May 4, 2009).
10.1 Amended and Restated Management and Advisory Agreement by and among the Registrant and FIG
LLC (formerly known as Fortress Investment Group LLC), dated June 23, 2003 (incorporated by
reference to the Registrant’s Statement on Form S-11 (File No. 333-106135), Exhibit 10.1).
10.2 Newcastle Investment Corp. Nonqualified Stock Option and Incentive Award Plan Amended and
Restated Effective as of February 11, 2004 (incorporated by reference to the Registrant’s Annual
Report on Form 10-K for the year ended December 31, 2005, Exhibit 10.2).
10.3 Exchange Agreement between Newcastle Investment Corp. and Taberna Preferred Funding IV, Ltd.,
Taberna Preferred Funding V, Ltd., Taberna Preferred Funding VI, Ltd. and Taberna Preferred Funding
VII, Ltd., dated April 30, 2009 (incorporated by reference to the Registrant’s Report on Form 8-K,
Exhibit 10.1, filed on May 4, 2009).
10. 4 Exchange Agreement, dated as of January 29, 2010, by and among Newcastle Investment Corp.,
Taberna Capital Management, LLC, Taberna Preferred Funding IV, Ltd., Taberna Preferred Funding
V, Ltd., Taberna Preferred Funding VI, Ltd. and Taberna Preferred Funding VII, Ltd. (incorporated by
reference to the Registrant’s Report on Form 8-K, Exchibt 10.1, filed on February 2, 2010).
12.1 Statements re: Computation of Ratios.
21.1 Subsidiaries of the Registrant.
31.1 Certification of Chief Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of Chief Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 12.1
RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED DIVIDENDS AND
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth our ratio of earnings to combined fixed charges and preferred dividends and our ratio of
earnings to fixed charges for each of the periods indicated:
Year Ended December 31,
2009 (C)
2008 (B)
2007 (A)
2006
2005
Ratio of Earnings to
Combined Fixed Charges and
Preferred Dividends
0.04
(8.32)
0.84
Ratio of Earnings to Fixed Charges
0.04
(8.68)
0.86
1.31
1.34
1.46
1.51
(A) The 2007 deficiencies in each ratio are $77.7 million and $65.1 million, respectively. The 2007 results included
impairment charges. Excluding such charges, the ratios would have exceeded 1 to 1.
(B) The 2008 deficiencies in each ratio are $2.99 billion and $2.98 billion, respectively. The 2008 results included
impairment charges. Excluding such charges, the ratios would have approximately equaled 1 to 1.
(C) The 2009 deficiencies in each ratio are $223.1 million and $209.6 million, respectively. The 2009 results included
impairment charges. Excluding such charges, the ratios would have exceeded 1 to 1.
For purposes of calculating the above ratios, (i) earnings represent “Income (loss) from continuing operations,” excluding
equity in earnings of unconsolidated subsidiaries, from our consolidated statements of operations, as adjusted for fixed
charges and distributions from unconsolidated subsidiaries, and (ii) fixed charges represent “Interest expense” from our
consolidated statements of operations. The ratios are based solely on historical financial information.
These ratios are affected by increasing interest rates. As a result of our match funded financing strategy, increasing interest
rates are expected to generally result in an increase to interest expense without a material effect on net income, thereby
negatively impacting these ratios.
Exhibit 21.1
NEWCASTLE INVESTMENT CORP. SUBSIDIARIES
STATE/COUNTRY OF
INCORPORATION/FORMATION
--------------------------------------------
1. 2520 Ridgewood GP, LLC
2. DBNC Peach Holding LLC
3. DBNC Peach I Trust
4. DBNC Peach LLC
5. Fortress Asset Trust
6. Fortress Realty Holdings, Inc.
7. Impac 1998-C1Carthage Texas, LLC
8. Impac CMB Trust 1998-C1
9. Impac Commercial Assets Corporation
10. Impac Commercial Capital Corporation
11. Impac Commercial Holdings, Inc.
12. Karl S.A.
13. LIV Holdings LLC
14. NCT Holdings II LLC
15. NCT Holdings LLC
16. Newcastle 2005-1 Asset-Backed Note LLC
17. Newcastle 2006-1 Asset-Backed Note LLC
18. Newcastle 2006-1 Depositor LLC
19. Newcastle CDO IV Corp.
20. Newcastle CDO IV Holdings LLC
21. Newcastle CDO IV, Ltd.
22. Newcastle CDO IX 1 Limited
23. Newcastle CDO IX 2 Limited
24. Newcastle CDO IX Holdings LLC
25. Newcastle CDO IX LLC
26. Newcastle CDO V Corp.
27. Newcastle CDO V Holdings LLC
28. Newcastle CDO V, Ltd.
29. Newcastle CDO VI , Ltd.
30. Newcastle CDO VI Corp.
31. Newcastle CDO VI Holding, LLC
32. Newcastle CDO VII Corp.
33. Newcastle CDO VII Holdings LLC
34. Newcastle CDO VII, Limited
35. Newcastle CDO VIII 1, Limited
36. Newcastle CDO VIII 2, Limited
37. Newcastle CDO VIII Holdings LLC
38. Newcastle CDO VIII LLC
39. Newcastle CDO X Holdings LLC
40. Newcastle CDO X Limited
41. Newcastle CDO X LLC
42. Newcastle Foreign TRS Ltd.
43. Newcastle MH I LLC
44. Newcastle Mortgage Securities LLC
45. Newcastle Mortgage Securities Trust 2004-1
Texas
Delaware
Delaware
Delaware
Delaware
Ontario
Texas
Delaware
California
California
Maryland
Belgium
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Delaware
Cayman Islands
Cayman Islands
Cayman Islands
Delaware
Delaware
Delaware
Cayman Islands
Delaware
Cayman Islands
Delaware
Delaware
Delaware
Exhibit 21.1
NEWCASTLE INVESTMENT CORP. SUBSIDIARIES
STATE/COUNTRY OF
INCORPORATION/FORMATION
46. Newcastle Mortgage Securities Trust 2006-1
47. Newcastle Mortgage Securities Trust 2007-1
48. Newcastle Trust I
49. NIC 2 River Place LLC
50. NIC 4 River Place LLC
51. NIC Airport Corporate Center LLC
52. NIC Apple Valley I LLC
53. NIC Apple Valley II LLC
54. NIC Apple Valley III LLC
55. NIC CRA LLC
56. NIC Dayton Towne Center LLC
57. NIC DB LLC
58. NIC DP LLC
59. NIC OTC LLC
60. NIC TP LLC
61. NIC TRS Holdings, Inc.
62. NIC TRS LLC
63. NIC WL II LLC
64. NIC WL LLC
65. Steinhage B.V.
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Netherlands
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Kenneth M. Riis, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Newcastle Investment Corp.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d – 15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d – 15(f)) for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant’s ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
February 19, 2010
(Date)
/s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Brian C. Sigman, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Newcastle Investment Corp.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d–15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d – 15(f)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant’s ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
February 19, 2010
(Date)
/s/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION OF CEO PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Newcastle Investment Corp. (the "Company") for the
annual period ended December 31, 2009 as filed with the Securities and Exchange Commission on the date
hereof (the "Report"), Kenneth M. Riis, as Chief Executive Officer of the Company, hereby certifies, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best
of his knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
/s/ Kenneth M. Riis
Kenneth M. Riis
Chief Executive Officer
February 19, 2010
This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall
not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been
provided to the Company and will be retained by the Company and furnished to the Securities and Exchange
Commission or its staff upon request.
EXHIBIT 32.2
CERTIFICATION OF CFO PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Newcastle Investment Corp. (the "Company") for the
annual period ended December 31, 2009 as filed with the Securities and Exchange Commission on the date
hereof (the "Report"), Brian C. Sigman, as Chief Financial Officer of the Company, hereby certifies, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best
of his knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
/s/ Brian C. Sigman
Brian C. Sigman
Chief Financial Officer
February 19, 2010
This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall
not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for
purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been
provided to the Company and will be retained by the Company and furnished to the Securities and Exchange
Commission or its staff upon request.
End of Filing
The following graph compares the cumulative total return for our common stock (stock price change plus rein-
vested dividends) with the comparable return of four indices: NAREIT All REIT, NAREIT Mortgage REIT,
Russell 2000, and S&P 500. The graph assumes an investment of $100 in the Company’s common stock and in
each of the indices on December 31, 2004 and that all dividends were reinvested. The past performance of our
common stock is not an indication of future performance.
Newcastle Investment Corp.
Stock Performance Chart
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Newcastle Investment Corp.
NAREIT All REIT
NAREIT Mortgage REIT
Russell 2000
S&P 500
Corporate Information
B OA R D O F D I R E C T O R S
C O R P O R AT E O F F I C E R S
C O R P O R AT E H E A D Q UA R T E R S
Kenneth M. Riis
Chief Executive Officer and President
Jonathan Ashley
Chief Operating Officer
Brian C. Sigman
Chief Financial Officer
Phillip J. Evanski
Chief Investment Officer
Randal A. Nardone
Secretary
Wesley R. Edens
Chairman of the Board
Principal and Co-Chairman
Fortress Investment Group LLC
Kevin J. Finnerty(1)
Founding Partner
Galton Capital Group
Stuart A. McFarland(1)
Managing Partner
Federal City Capital Advisors, LLC
David K. McKown(1)
Senior Advisor
Eaton Vance Management
Peter M. Miller(1)
Chief Executive Officer
Whitehead Miller Advisors, Inc.
Kenneth M. Riis
Managing Director
FIG LLC
(1) Member of Audit Committee, Nominating
and Corporate Governance Committee
and Compensation Committee
Newcastle Investment Corp. filed timely CEO and CFO certifications with the Securities and
Exchange Commission pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 regarding
Newcastle’s annual report on Form 10-K for the year ended December 31, 2009. These certifications
were filed as exhibits 31.1 and 31.2 to such Form 10-K.
Newcastle Investment Corp.
c/o Fortress Investment Group LLC
1345 Avenue of the Americas, 46th Floor
New York, NY 10105
(212) 798-6100
Independent Auditors
Ernst & Young LLP
Five Times Square
New York, NY 10036-6530
Stock Transfer Agent and Registrar
American Stock Transfer & Trust Company, LLC
59 Maiden Lane
Plaza Level
New York, NY 10038
(800) 937-5449
Stock Exchange Listing
Newcastle Investment Corp.’s common stock
is listed on the New York Stock Exchange
(symbol: NCT)
Annual Meeting of Stockholders
June 2, 2010, 8:00 a.m.
Hilton New York
Sutton North Room
1335 Avenue of the Americas
New York, NY 10019
Investor Information Services
Nadean Finke
Vice President, Investor Relations
Newcastle Investment Corp.
c/o Fortress Investment Group LLC
1345 Avenue of the Americas, 46th Floor
New York, NY 10105
Tel: (212) 479-5295
Fax: (212) 798-6133
e-mail: nfinke@fortress.com
Newcastle Investment Corp. website
http://www.newcastleinv.com
printed on recycled paper
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Newcastle Investment Corp.
1345 Avenue of the Americas
46th Floor
New York, NY 10105 USA
(212) 798-6100
www.newcastleinv.com